The Role of Deposit Guarantee Schemes in Preventing and Managing Banking Crises : Governance and Least Cost Principle

The Deposit Guarantee Directive enlarges the role of DGSs in supporting and financing with alternative interventions, the early research of “market solutions” that may avoid the failure of a bank. Despite the broad mandate formally set out in the Directive, the feasibility of the failure prevention measures by a DGS could be somehow restricted according to the current legal framework. More specifically, constraints to the use of alternative interventions could derive both from State aid rules and the introduction of depositor preference coupled with the least cost criterion. Given the importance of the role of DGSs in preventing and minimizing the overall cost of a banking crisis, this paper aims at analysing the two issues above, in order firstly to suggest a governance model which allows a national DGS to intervene in a banking crisis without breaking State aid rules. Secondly, with refer to the least cost principle, the paper suggests the adoption of some criteria, extrapolated by the DGSD, which may allow DGSs to overcome to problems arising from the combination of the above principle with the super priority rule