Sub-Theme 1 | Korea Deposit Insurance Corporation
1. Introduction of Deposit Insurance System in Korea
Korea’s deposit insurance system came into existence on June 1, 1996, with the establishment of the Korea Deposit Insurance Corporation (KDIC). The KDIC embarked on the task of deposit insurance protection as an ex-ante prefunded system for banks. In addition, each non-bank financial sector had its own method of depositor protection, usually in the form of a fund. When the financial crisis occurred in late 1997, the government was able to immediately use the KDIC as an instrument of public policy.
Major functions of the KDIC are as follow:
(1) Funding and management of deposit insurance funds;
(2) Risk management to prevent insolvency of insured financial institutions;
(3) Depositor reimbursement and resolution of failed financial institutions;
(4) Recovery of assistance through sale of assets and bankruptcy dividends.
All financial institutions operating in Korea under the licenses of the Financial Supervisory Service (FSS) and special banks are required to be insured by the KDIC. The total number of insured financial institutions increased to 324 in 2011 (55 banks, 117 financial investment companies, 44 insurance companies, 1 merchant bank and 107 mutual savings banks (MSBs)) from 322 in 2010.
Korea’s deposit insurance scheme adopted the limited coverage scheme in 1996. The deposit protection limit of Korea’s deposit insurance scheme was initially 20 million won per depositor in 1996.
Insurable deposits are depository products sold by insured financial institutions under Article 2 of the DPA. The total amount of insurable deposits reached 1,161 trillion (1.16 quadrillion) won at the end of 2010. By financial sector, banks accounted for 738 trillion won, financial investment companies for 22 trillion won, insurance companies for 323 trillion won, merchant banks for 1 trillion won, and MSBs for 77 trillion won.
The single integrated deposit insurance system in Korea provides a protection for up to 50 million won to deposits held by not only banks, but also finance investment companies, insurance companies, merchant banks and mutual savings banks.
In the beginning, the Korean deposit insurance system was classified as a “pay-box system” in view of its role and responsibilities defined by its law and actual business activities. The Korean deposit insurance system was not intended to deal with systemic crises like the 1997 financial crisis.
2. Deposit Insurance System After 1997 Financial Crisis
The outbreak of the financial crisis caused many decisions and events that had a huge impact on the deposit insurance system. Limited coverage was changed to blanket coverage to stabilize the financial system during the crisis and to protect depositors.
As a result, the deposit insurance scheme in Korea has become considerably exposed to moral hazards. The government reintroduced a limited coverage system in January 2001 to deal with the moral hazard problem and to strengthen market discipline after the second round of restructuring was finished. The KDIC raised the coverage limit from 20 million won to 50 million won in order to prevent withdrawals by large depositors and to maintain financial stability.
Insurance premium rates for insured financial institutions were raised several times after the financial crisis of 1997 to strengthen and reinstate the financial health of the Deposit Insurance Fund. Insurance premium rates for banks and mutual savings banks reached 0.08% and 0.40%, respectively.
The role and function of the KDIC were enlarged in several ways in order to support and facilitate the process of financial restructuring after the financial crisis of 1997. The Korean deposit insurance system has developed an advanced administrative process for resolving failures of financial institutions and has been, in general, effective in protecting small savers. Now the KDIC is classified by the Financial Stability Board as a deposit insurer with a “risk minimizer” mandate.
Events during the financial crisis of 1997 revealed the importance of effective and explicit prefunded depositor protection systems. Korea’s experiences in adopting and operating the explicit prefunded deposit insurance system demonstrate that the explicit prefunded deposit insurance scheme is a better choice than reliance on implicit deposit protection.
The government and the KDIC could implement faster and smoother failure resolutions of insolvent financial institutions because they could operate on the basis of established rules and procedures set in the Depositor Protection Act. The KDIC acted as agent of the government to issue Deposit Insurance Fund bonds guaranteed by the government, executed resolution methods determined by the Financial Supervisory Commission (FSC), and fulfilled recovery functions. The functions of KDIC were expanded in several ways to support and facilitate the process of financial restructuring after the financial crisis.
3. Financial System Safety Net
The explicit prefunded deposit insurance scheme in Korea has been a part of a well-designed financial safety net, supported by strong prudential regulation and supervision of financial institutions conducted by the Financial Services Commission (FSC) and the Financial Supervisory Service (FSS), effective laws that are established and enforced by the Ministry of Strategy and Finance (MOSF) and the government, and an adequate amount of deposit insurance funds and public funds mobilized by the government and the KDIC.