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The deposit base of countries with weak sovereigns can become fragile because depositors are able to easily and abruptly shift deposits to institutions based in other countries, in particular in the common currency euro area.
Two steps are needed to prevent destabilising cross-border movements of deposits. First, further cross-country harmonisation of deposit insurance schemes is necessary to prevent deposit shifts driven by remaining differences in insurance coverage. But this is not sufficient. Deposit guarantee schemes are unfunded in many countries, and the fiscal position could be affected significantly by the failure of a large institution. Second, member countries should aim for a pan EU-scheme and reach common agreements on the conditions that would need to be met in terms of coordination, cooperation and fiscal harmonisation to make such a scheme work. There would need to be collective backing by all member countries. Such a scheme, complemented with a resolution component, would also help deal efficiently with the failure of cross-border banks within the EU.
A pan EU-deposit guarantee scheme could be pre-funded by a harmonised bank levy on selected bank liabilities or a financial activity tax (FAT). A FAT, where the base is the sum of profits and remuneration paid by banks, comes close to mimicking a VAT on financial services. A financial transaction tax, as recently proposed by the Commission, would be less attractive because of its potential distortionary effects and scope for evasion. In addition, the EU-scheme could borrow on financial markets—with appropriate backing from member countries—to finance depositor payouts. For the euro area, consideration should be given to embedding this in the general permanent crisis management toolkit envisaged with the forthcoming European Stability Mechanism, which is in the process of being finalised, with clear rules on the circumstances under which the funds could be used.