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This work is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License
Article
Evaluation of Deposit Insurance Fund Adequacy Using Credit Risk Model—An Indian Experience
Author(s)
Steward Doss
Full-Text PDF
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DOI:10.17265/1537-1506/2017.05.001
Affiliation(s)
National Insurance Academy, Pune, India
ABSTRACT
There are two methods widely
used for evaluating the adequacy of Deposit Insurance Fund: (i) Target Reserve Ratio
and (ii) Credit Risk Model. Target Reserve Ratio is one of the macro level indicators
more often set by Regulatory act on the basis of minimum Deposit Insurance Fund
margin safety. Target Reserve Ratio is calculated as the ratio of Deposit Insurance
Fund to the value of insured deposits. However, TRR does not take into consideration the
level of Deposit Insurance potential liability, the Loss at Given Default (LGD) and the historical trend of default rate prevailing
among the insured banks. It does not also consider the present condition of the
economy and current scenario of the banking sector.
This paper discusses primarily about development of Credit
Risk Model for evaluating the Deposit Insurance Fund Adequacy. For this purpose,
Econometric Credit Risk Model was developed based on the historical data of bank
failures and the associated losses of the last 25 years from 1990-91 to 2014-15.
The model assesses various possible factors impacting the Deposit Insurance Fund:
Default rate, Deposit growth, Exposures, impact of macro-economic factors like
GDP, GDS, Inflation and Interest rate changes, etc. on the Deposit Insurance Fund through econometric modeling. The
model evaluates the adequacy of Deposit Insurance Fund under both (i) Normal scenarios
where there is no (economic) systemic risk assumed and (ii) Worst case scenario
at 1% level of significance using Monte Carlo Simulation. Since
the model empirically validates all the critical factors impacting the assets and
liabilities associated with Loss at Given
Default, the model output can also be used to determine
a suitable Target Reserve Ratio and such models are being used in countries like
USA, Canada, Hong Kong, and Singapore, etc. (IADI, 2009). More importantly, the
model outputs are quite useful in determining the adequacy of deposit insurance
fund which is an effective risk control measure that organization like Deposit Insurance
Credit Guarantee Corporation (DICGC) can adopt both under normal economic scenario
as well as worst case scenario, ensuring a strong financial safety net for the banking
sector in India. The model also assesses the default probability and the Loss at Given
Default of different types of banks: commercial banks,
rural banks, cooperative banks, foreign banks, etc. A risk
based on premium can possibly be determined for each type
of banks in India.
KEYWORDS
default probability, Loss at Given Default, Target Reserve Ratio, assessable deposits, cash reserve ratio, capital to risk weighted asset ratio
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