The Role Of Microfinance Banks IN The Economic Development of a Natio

ISSUES IN FUNDING OF DEPOSIT INSURANCE SYSTEM: LESSONS FOR NIGERIA

BY

Hashim I. Ahmad Deputy Director Research, Policy and International Relations Department

ABSTRACT The paper attempts to give insights into the criticality of funding to the implementation of deposit insurance system (DIS) as well as highlights the various issues involved in funding the system. In the course of examining the funding issues, experiences of some countries, namely, the United States of America, Malaysia, The Philippines and Japan as well as best practices as represented by the International Association of Deposit Insurance (IADI) Core Principles for Effective Deposit Insurance System were reviewed and lessons for the deposit insurance system in Nigeria were drawn. The funding issues reviewed by the author ranges from funding methods to funding sources, premium assessment, determination of the adequacy of funds, separate or merged funding and fund management. The lessons drawn for the deposit insurance system in Nigeria from the review of practices in other countries and best practice are in the areas of: Target Fund Ratio; Premium Assessment; Treatment of Operating Surplus; Separate or Merged Funding Arrangement; and Investment Policy.

1.0 INTRODUCTION Formal deposit insurance has been in practice since 1934. It has witnessed rapid growth particularly in recent times following the recent global financial crisis. As at 2011, there were a total of 111 countries practicing explicit deposit insurance system (IADI, 2011). Whereas some countries have more than one deposit insurance system (e.g. Austria, Canada, Columbia, Cyprus, Germany, Italy, USA and Portugal), others have single system covering more than one country (e.g. FDIC covers The Marshall Islands, Micronesia, and Puerto Rico). In a deposit insurance survey involving 79 countries conducted by IADI in 2011, 49 countries had ex ante funding arrangement, 9 had ex post funding arrangement while 16 countries had hybrid funding arrangement (IADI, 2011).

Funding is very essential to the implementation of Deposit Insurance System (DIS), regardless of the type in practice. Funding is very essential to the implementation of Deposit Insurance System (DIS), regardless of the type in practice. It is in realization of this that IADI and Basel Committee for Banking Supervision (BCBS) made it one of the Core Principles for Effective Deposit Insurance System. It is in realization of this that IADI and Basel Committee for Banking Supervision (BCBS) made it one of the Core Principles for Effective Deposit Insurance System. According to IADI Core Principle 11, "A deposit insurance system should have available all funding mechanisms necessary to ensure the prompt reimbursement of depositors' claims including a means of obtaining supplementary back-up funding for liquidity purposes when required" (IADI, 2009). According to IADI Core Principle 11, "A deposit insurance system should have available all funding mechanisms necessary to ensure the prompt reimbursement of depositors' claims including a means of obtaining supplementary back-up funding for liquidity purposes when required" (IADI, 2009). It therefore means that a DIS must have access to adequate sources of funding to meet its obligations when they fall due and to cover its operations' expenses. It therefore means that a DIS must have access to adequate sources of funding to meet its obligations when they fall due and to cover its operations' expenses. Furthermore, IADI, through its Research and Guidance Committee had developed a guidance paper on funding with a view to assisting jurisdictions either wishing to set-up new systems or undertaking a review of the existing one. Furthermore, IADI, through its Research and Guidance Committee had developed a guidance paper on funding with a view to assisting jurisdictions either wishing to set-up new systems or undertaking a review of the existing one. Indeed funding to a DIS could influence, to a large extent, the credibility of the scheme and the public confidence in the scheme, thus enhancing or impairing its stabilizing capability; among other factors (Diz, 2004). Indeed funding to a DIS could influence, to a large extent, the credibility of the scheme and the public confidence in the scheme, thus enhancing or impairing its stabilizing capability; among other factors (Diz, 2004). However, it is imperative to note that regardless of how DIS is funded, it is not designed to withstand, on its own, a systemic crisis, especially when large proportion of insured depository institutions are in severe trouble or a large insured institution fails at the same time. However, it is imperative to note that regardless of how DIS is funded, it is not designed to withstand, on its own, a systemic crisis, especially when large proportion of insured depository institutions are in severe trouble or a large insured institution fails at the same time. Nor should it be assigned the responsibility of funding such a crisis. Nor should it be assigned the responsibility of funding such a crisis. Policymakers should therefore consider how failures would be handled, both in normal times and in times of stress (IADI, 2009). Policymakers should therefore consider how failures would be handled, both in normal times and in times of stress (IADI, 2009).

In Nigeria, the type of DIS in practice necessitates the availability of a funding arrangement for the insurance agency to be able to discharge its mandate and at the same time sustain its operations. In Nigeria, the type of DIS in practice necessitates the availability of a funding arrangement for the insurance agency to be able to discharge its mandate and at the same time sustain its operations. Although the system has been in practice in the country for over two decades, there are some lessons that could still be learned from the experiences of other countries particularly in the area of

funding. It is in the light of this that this paper seeks to examine the various issues in DIS funding as well as draw some lessons for the system in Nigeria.

To achieve the above objectives, the rest of the paper is divided into five sections. To achieve the above objectives, the rest of the paper is divided into five sections. Section 2 examines some conceptual issues in funding of DIS. Section 2 examines some conceptual issues in funding of DIS. Section 3 gives a cross country experiences in funding deposit insurance, while section 4 looks at the funding arrangement for the DIS in Nigeria. Section 3 gives a cross country experiences in funding deposit insurance, while section 4 looks at the funding arrangement for the DIS in Nigeria. Section 5 draws lessons from best practices and practices in other jurisdictions for the system in Nigeria. Section 5 draws lessons from best practices and practices in other jurisdictions for the system in Nigeria. Section 6 concludes the paper. Section 6 concludes the paper.

2.0 CONCEPTUAL ISSUES IN DIS FUNDING 2.1 Funding Methods Different funding methods exist for the use of deposit insurers, but suffice it to say that whether one method is preferred to the other will depend in part, on individual jurisdictions' circumstances, developments in their financial systems, the history of financial crisis as well as the deposit insurance system's public policy objectives and design.

DIS is funded in several ways depending on the type, environment and the level of crisis confronting the banking system, which the insurer would have to resolve. DIS is funded in several ways depending on the type, environment and the level of crisis confronting the banking system, which the insurer would have to resolve. As found in the literature, DIS is financed through either ex-ante premium collection or through ex-post levies or via a combination of ex-ante and ex-post mechanisms (IADI, 2006).

i) Ex ante Funding Method This is a method by which the DIS agency generates funds before bank failure. This is a method by which the DIS agency generates funds before bank failure. The funds are usually generated through periodic premium contributions by participating institutions. The funds are usually generated through periodic premium contributions by participating institutions. The frequency of the collection varies as some deposit insurance agencies collect premium on a biannual basis while majority collect on

an annual basis. Some of the advantages of ex-ante system of funding according to Diz (2004) include the following:

i) It is transparent and tends to enhance confidence in the efficacy of the scheme;

ii) It is incorporated in the banks' planning and includes the contribution of any failing bank, thus improving the fairness of the scheme;

iii) It permits funding to be accumulated slowly over time, thus spreading, rather than concentrating, the costs to the participants;

iv) By making available a pool of resources that can be invested in low-risk, highly liquid, domestic or foreign assets it can avoid most of the risks usually associated with episodes of banking difficulties or the foreign exchange risk of insuring foreign currency-denominated deposits;

v) By being readily available when a failure occurs, it allows the insurer to apply its funds without undue delays and with no liquidity pressure on banks at critical moments;

vi) By gradually creating a cushion paid for by the banking industry, it helps to raise the probability of safeguarding taxpayers from financing bank failures; and

vii) It is more amenable to the introduction of differential premiums.

A drawback of an ex-ante system of funding DIS is that, like any insurance system, it increases moral hazard, that is to say it creates an incentive for member institutions to take on more risk than they otherwise might (IADI, 2006).

ii) Ex Post Funding Method It is a method in which participating institutions are assessed for premium payment after bank failures. It is a method in which participating institutions are assessed for premium payment after bank failures. It seems to be less popular as a funding method

than the ex ante method as revealed by the result of a survey conducted by IADI in 2011. The survey indicated that only nine (9) out of 79 respondent countries use ex post method in funding their DIS (IADI, 2011).

One of the advantages of ex-post system of funding DIS is that it is less onerous during periods when there are no or few failures because premiums are not continually collected. One of the advantages of ex-post system of funding DIS is that it is less onerous during periods when there are no or few failures because premiums are not continually collected. Another advantage is that it is less expensive in the long run than the ex-ante system since it avoids the administrative cost associated with the on-going collection of premiums and portfolio management of the funds.

The disadvantages of the ex-post system include:

i) It is less equitable because a failed institution would not have contributed to the cost of reimbursing its depositors;

ii) It carries greater financial risk for the government;

iii) Prompt reimbursement of depositors may be difficult since the systems, procedures and qualified personnel may not be in place to collect and distribute the required funds.

iii) Hybrid Funding Method The hybrid funding method combines features of both ex-ante and ex-post funding methods. The hybrid funding method combines features of both ex-ante and ex-post funding methods. It incorporates an ex-ante fund financed by premiums contributions and includes a mechanism to obtain funds ex-post from member institutions, through special premiums, levies or loans, should the need arises. For instance, a DIS adopting ex ante funding arrangement could be empowered to levy ex-post contributions to make up for any fund shortfall. For instance, a DIS adopting ex ante funding arrangement could be empowered to levy ex-post contributions to make up for any fund shortfall. Hybrid funding method is relatively more popular than the ex post. Hybrid funding method is relatively more popular than the ex post. In a survey conducted by IADI in 2011, 16 out of 79 countries used hybrid funding method. In a survey conducted by IADI in 2011, 16 out of 79 countries used hybrid funding method. With ex-ante funding, under very adverse circumstances, losses may exceed the fund's reserve which may necessitate access to other sources of funding outside regular

premium collection, as in the case of FDIC during the recent financial crisis. Thus, in practice, the real choice may not be between pure ex-ante and ex-post funding, but the relative extent to which the deposit insurance system relies on both (IADI, 2006).

The level of DIF at any given time is dependent on the premium rate charged and assessment base used. The level of DIF at any given time is dependent on the premium rate charged and assessment base used. Where the level of DIF cannot cope with the level of distress in the system, adjustment of the premium rate and/or assessment base may be required, with a view to raising the level of DIF and vice visa.

2.2 Funding Sources The sources of funds for a deposit insurance system could come from either the private sector or public sector or both.

i) Private Sources This is a situation where funds are raised through premium contribution by the participating institutions. This is a situation where funds are raised through premium contribution by the participating institutions. The premium amounts due from each particularly institution, are determined by applying the premium rate to the assessment base. The premium amounts due from each particularly institution, are determined by applying the premium rate to the assessment base. Where the funds contributed by participating institutions through regular premium contribution turn out to be insufficient following a failure, the deposit insurance agency may resort to other sources of funding such as special premiums or levies to bridge the funding gap.

ii) Public Sources Most deposit insurance systems have arrangements that enable them access public sector fund when the need arises. Most deposit insurance systems have arrangements that enable them access public sector fund when the need arises. The public sector funding takes the form of initial contributions from government at the take off stage of the system, loan from government or central bank to cover special circumstances and grants to cover losses. The public sector funding takes the form of initial contributions from government at the take off stage of the system, loan from government or central bank to cover special circumstances and grants to cover losses. Most DIS rely on government funds for an initial capital injection to establish the system (IADI, 2008). Most DIS rely on government funds for an initial capital injection to establish the system (IADI, 2008). That was based on the argument that the

promotion of financial system stability and the operation of a financial safety net are important government objectives which benefit the country as a whole, and therefore it is appropriate for the public sector to give the system some financial support by providing some initial capital to establish a fund and/or provide supplementary funding in crisis situations. In some jurisdictions, central bank or government directly grants the deposit insurer line of credit. In some jurisdictions, central bank or government directly grants the deposit insurer line of credit. Experience has shown that it is less expensive for the deposit insurance agency to obtain funds from the public sector than obtain loans from the private sector, as the public sector can raise funds at lower cost, given its credit rating.

iii) Contingent Financing Sources Where the deposit insurance system finds itself with inadequate funds in reserve to meet its commitments, the gap between resources and financial obligations of a deposit insurer can be covered through back-up financing from sources such as government, the market or multilateral financial institutions like the International Monetary Fund (IMF) or the World Bank. Where the deposit insurance system finds itself with inadequate funds in reserve to meet its commitments, the gap between resources and financial obligations of a deposit insurer can be covered through back-up financing from sources such as government, the market or multilateral financial institutions like the International Monetary Fund (IMF) or the World Bank. The backup funding allows for a prompt reimbursement of insured deposits and could be repaid through special levies on the surviving institutions. The backup funding allows for a prompt reimbursement of insured deposits and could be repaid through special levies on the surviving institutions. Where contingent funding mechanism is in place, it is important for the deposit insurer to have clearly defined rules on its use so that the funds will not be excessively relied upon or misappropriated.

Although most deposit insurers are government agencies, a government guarantee may nevertheless reduce the cost of borrowing from the private sector since it can enhance the credit rating of the financial instrument used. Although most deposit insurers are government agencies, a government guarantee may nevertheless reduce the cost of borrowing from the private sector since it can enhance the credit rating of the financial instrument used. In some cases, the lack of a government guarantee may even block access to private sector credit.

2.3 Premium Assessment A principal means through which a deposit insurer raises funds as indicated earlier, is through premium contributions by participating institutions. A principal means through which a deposit insurer raises funds as indicated earlier, is through premium contributions by participating institutions. The framework for the assessment of premiums should be clearly defined. The framework for the assessment of premiums should be clearly defined. It is usually determined using a rate and the assessment base, taking into account the funding needs of the insurer and the ability of the participating institutions to pay. Policymakers must determine both the assessment base as well as the premium rate and method.

2.3.1 Assessment Base Premium assessment base is the amount to which the rate is applied to arrive at the premium level collectible from a member institution. Premium assessment base is the amount to which the rate is applied to arrive at the premium level collectible from a member institution. The most widely used assessment bases are insured and total deposits. The most widely used assessment bases are insured and total deposits. However, some jurisdictions use broader bases which include domestic liabilities or all liabilities and obligations while some use other variables such as non-performing loans or risk- weighted assets. However, some jurisdictions use broader bases which include domestic liabilities or all liabilities and obligations while some use other variables such as non-performing loans or risk- weighted assets. In a survey involving 87 countries practicing deposit insurance conducted by IADI in 2008, statistics revealed that 43 countries, including Brazil, Canada, Taiwan Korea, Japan, used insured deposits as assessment base, while 29 countries including USA, Philippines, Kenya, Argentina, used total deposits and the remaining 15 countries used other indices such as risk weighted assets (e.g. Norway and Poland), credit accounts (e.g. Lebanon) etc as bases for premium assessment.

Total deposits in this case, refer to all deposits in all categories that are covered, including amounts in excess of the limit on insurance claims. Total deposits in this case, refer to all deposits in all categories that are covered, including amounts in excess of the limit on insurance claims. Insured deposits are the amount of deposits that are protected within the limit of insurance claims. Insured deposits are the amount of deposits that are protected within the limit of insurance claims. Calculating premiums on the basis of total deposits means that premiums would be charged even on deposits, which are in excess of insurance coverage level. Calculating premiums on the basis of total deposits means that premiums would be charged even on deposits, which are in excess of insurance coverage level. Although, insured deposits are the most widely used base for premium assessment, it has been argued that it does not fetch more premiums to the deposit insurer and can be more complex to administer. Although, insured deposits are the most widely used base for premium assessment, it has been argued that it does not fetch more premiums to the deposit insurer and can be more complex to administer. However, it has been observed that charging premiums on insured deposits appear more equitable

since the premium payable is equated to the perceived level of protection offered by the deposit insurance system (NDIC, 1999).

Total deposits on the other hand though not widely used as seen from the survey by IADI, it was mostly popular amongst newly established systems that needed to build their DIF as rapidly as possible. Total deposits on the other hand though not widely used as seen from the survey by IADI, it was mostly popular amongst newly established systems that needed to build their DIF as rapidly as possible. The use of total deposits for premium assessment seems to be fetching more money to the DIF than the insured deposits. The use of total deposits for premium assessment seems to be fetching more money to the DIF than the insured deposits. It is however not equitable, which is the advantage that the use of insured deposit has over it (IADI, 1999).

2.3.2 Assessment Method The premium systems could be either flat rate or differential (risk-adjusted).

Flat-Rate Premium Approach: i) This is a situation where member institutions are assessed using the same rate. This is a situation where member institutions are assessed using the same rate. It is relatively straightforward to implement and less cumbersome to calculate. It is relatively straightforward to implement and less cumbersome to calculate. The flat rate premium system has the advantage of ease of administration and provides the deposit insurer the opportunity to rapidly build the deposit insurance fund. The flat rate premium system has the advantage of ease of administration and provides the deposit insurer the opportunity to rapidly build the deposit insurance fund. That is why most newly established or transitional systems always go for the flat rate assessment method (Hoelscher et al, 2006). That is why most newly established or transitional systems always go for the flat rate assessment method (Hoelscher et al, 2006). The major disadvantage of the method, however, is that it is inequitable since low- risk institutions tend to subsidize high-risk institutions and the exposure to moral hazards is higher.

ii) Risk-Adjusted/Differential Premium System This is a method that incorporates the risk posed by a member institution to the deposit insurer into the premium assessment structure. This is a method that incorporates the risk posed by a member institution to the deposit insurer into the premium assessment structure. The approach reduces the moral hazard issue by providing member institutions with an incentive to be more prudent in their operations. The approach reduces the moral hazard issue by providing member institutions with an incentive to be more prudent in their operations. The method appears more equitable, since cross-subsidization among institutions is greatly reduced. The method appears more equitable, since cross-subsidization among institutions is greatly reduced. In a risk-related

method, premium is charged based on the relative risk of failure, that is, banks that engage in riskier behaviour would pay higher premium rate and in the process restores the elements of market discipline (Demirguc-Kunt, et al, 2005).

One of the advantages of risk-adjusted systems is that it can lead to pressure by the member institution's board of directors on management to address risk- related issues when premium rates are high. One of the advantages of risk-adjusted systems is that it can lead to pressure by the member institution's board of directors on management to address risk- related issues when premium rates are high. One of the disadvantages of risk- adjusted assessment systems is that it is more complex to develop and administer. One of the disadvantages of risk- adjusted assessment systems is that it is more complex to develop and administer. Furthermore, the adoption of this approach could lead to reduction in premium collectible particularly for jurisdictions transiting from a flat rate system to a risk-adjusted assessment system and this has implications for the deposit insurance fund. Furthermore, the adoption of this approach could lead to reduction in premium collectible particularly for jurisdictions transiting from a flat rate system to a risk-adjusted assessment system and this has implications for the deposit insurance fund. In terms of the applicability of the risk-adjusted premium system, there has been significant increase in the number of countries using it. In terms of the applicability of the risk-adjusted premium system, there has been significant increase in the number of countries using it. As at 2011, there was a total of 24 countries using risk-adjusted premium assessment system (IADI, 2011)1.

A critical requirement for the deployment of a risk-adjusted premium assessment system is finding an appropriate method for differentiating among the risk profile of banks. A critical requirement for the deployment of a risk-adjusted premium assessment system is finding an appropriate method for differentiating among the risk profile of banks. There are different approaches for differentiating the risk profile of banks. There are different approaches for differentiating the risk profile of banks. The most common approaches include, among others, Quantitative Criteria Approaches, Qualitative Criteria Approaches and Combined Quantitative and Qualitative Criteria Approaches. The most common approaches include, among others, Quantitative Criteria Approaches, Qualitative Criteria Approaches and Combined Quantitative and Qualitative Criteria Approaches. Although the approaches are difficult to accomplish, the approach chosen by any deposit insurer for differentiating risks and assignment of premium rates should be forward looking (IADI, 2011).

The quantitative criteria approaches generally try to use measures that are factual or data driven to categorize banks for premium assessment purposes.

1 This was based on the results of the CDIC International Deposit Insurance Surveys (2003 and 2008), Garcia (1999), and the surveys conducted during the updating of the General Guidance for Developing Differential Premium Systems.

Some quantitative systems rely on only one factor to assess risk while others combine a number of factors. Factors that are commonly considered for such systems usually include (IADI, 2011):

i) a bank's adherence with regulatory capital requirements or other measures of the quantity, quality and sufficiency of a bank's capital;

ii) the quality and diversification of a bank's asset portfolio both on and off- balance sheet; the sufficiency, volatility and quality of a bank's earnings;

iii) a bank's cash flows (both on and off-balance sheet) and ability to generate and obtain sufficient funds in a timely manner and at a reasonable cost;

iv) the stability and diversification of a bank's funding; and

v) a bank's exposure to interest rate risk, and where applicable, foreign exchange and position risk.

The qualitative criteria approaches generally rely on a number of qualitative factors to categorize banks into different categories for premium assessment purposes. The qualitative criteria approaches generally rely on a number of qualitative factors to categorize banks into different categories for premium assessment purposes. The primary method used is reliance on some form of regulatory and supervisory judgment or rating system and information such as adherence to guideline, standards, compliance measures or other supervisory or deposit insurance requirements (IADI, 2011).

The combined quantitative and qualitative criteria approaches use both quantitative and qualitative measures to categorize banks. The combined quantitative and qualitative criteria approaches use both quantitative and qualitative measures to categorize banks. This appears to be the most common approach being used by deposit insurance systems, like: Canada, USA, Malaysia, Taiwan, Turkey Argentina, Nigeria and Kazakhstan, among others (IADI, 2011). This appears to be the most common approach being used by deposit insurance systems, like: Canada, USA, Malaysia, Taiwan, Turkey Argentina, Nigeria and Kazakhstan, among others (IADI, 2011). A critical point of note in systems which combine both quantitative and qualitative factors, as indicated in the IADI Guidance Paper on Differential Premium Assessment System (DPAS), is the relative weighting of the factors. A critical point of note in systems which combine both quantitative and qualitative factors, as indicated in the IADI Guidance Paper on Differential Premium Assessment System (DPAS), is the relative weighting of the factors. It has been observed that in some systems quantitative criteria receive equal

weight as qualitative factors. Yet in many other jurisdictions, such as Canada, qualitative criteria are weighted less than quantitative criteria. Yet in many other jurisdictions, such as Canada, qualitative criteria are weighted less than quantitative criteria. The advantage of a combined criteria approach is that it can be a highly effective and comprehensive way to assess the risk profile of banks. The advantage of a combined criteria approach is that it can be a highly effective and comprehensive way to assess the risk profile of banks. However, the main shortcoming of the approach is that it may impose a higher level of information requirements on banks and could be more open to challenges compared to approaches using mostly quantitative criteria (IADI, 2011).

Although there are a wide variety of approaches to differentiate risk among banks and assign premium rates, the approach chosen should: be effective at differentiating banks into appropriate risk categories; utilize a variety of relevant information; be forward looking; and be well accepted by the banking industry and financial safety-net participants (IADI, 2011). Although there are a wide variety of approaches to differentiate risk among banks and assign premium rates, the approach chosen should: be effective at differentiating banks into appropriate risk categories; utilize a variety of relevant information; be forward looking; and be well accepted by the banking industry and financial safety-net participants (IADI, 2011). It is also imperative to note that risk-adjusted assessment method is administratively demanding and is unlikely to work well unless supported by effective supervision and regulation, and prompt intervention (Hoelscher et al, 2006).

2.4 Determining the Adequacy of DIF A deposit insurance system that uses an ex ante funding arrangement will need to charge premiums and accumulate funds that would be adequate for the system. A deposit insurance system that uses an ex ante funding arrangement will need to charge premiums and accumulate funds that would be adequate for the system. Determining the adequacy of the fund requires detailed knowledge of the condition of a country's banking system and deposit insurance system (Hoelscher et al, 2006). Determining the adequacy of the fund requires detailed knowledge of the condition of a country's banking system and deposit insurance system (Hoelscher et al, 2006). Two approaches of determining the fund adequacy as found in the literature are: target reserve ratio and credit portfolio approach (IADI, 2009).

Target reserve ratio provides a measure of how large an adequate reserve should be. Target reserve ratio provides a measure of how large an adequate reserve should be. The target fund level should be at least adequate to cover the potential losses of the insurer under normal circumstances. The target fund level should be at least adequate to cover the potential losses of the insurer under normal circumstances. A large number of factors need to be taken into account including: the composition of member

banks (number, size, lines of business); the liabilities of members and the exposure of the insurer to them; the probability of failures; and the characteristics of losses that the insurer can expect (IADI, 2009). banks (number, size, lines of business); the liabilities of members and the exposure of the insurer to them; the probability of failures; and the characteristics of losses that the insurer can expect (IADI, 2009). It is pertinent to indicate that target reserve is mainly a proxy as deposit insurers and the member institutions can be exposed to a wide range of factors that are difficult to specify in advance.

There are several methods of calculating the appropriate size of target fund ratio. There are several methods of calculating the appropriate size of target fund ratio. The most common of the methods, which is widely used by a number of countries is that which considers the country's historical experience with bank failures and associated losses (IADI, 2009). The most common of the methods, which is widely used by a number of countries is that which considers the country's historical experience with bank failures and associated losses (IADI, 2009). Some of the advantages of this approach are that it is relatively straightforward, it is easy to understand and it relies on existing information. Some of the advantages of this approach are that it is relatively straightforward, it is easy to understand and it relies on existing information. Its major shortcomings is that it does not take into account the current risk profile of member institutions as well as other information, which may be useful in assessing potential losses to the deposit insurer (IADI, 2009).

Some of the advantages of adopting target fund ratio under an ex ante funding arrangement according to Yvonne (2008) include: to prevent delay in bank resolution; to avoid pro-cyclical effect on the economy; to reduce political interference; to relieve burden on taxpayers; to demonstrate a calculable funding regime to the industry; and to enhance financial health of a deposit insurer and public confidence in sustainable DIS.

As at December 31, 2007, there were a total of 15 countries² using target fund ratio for determining the adequacy of Deposit Insurance Fund. As at December 31, 2007, there were a total of 15 countries² using target fund ratio for determining the adequacy of Deposit Insurance Fund. The average of

2 The countries are: Venezuela (10.11%), Colombia (5.00%), Jordan (3.00%, Tanzania (2.70%, Indonesia (2.50%), Jamaica (2.00-2.25%), Brazil (2.00%), USA (1.25%), Argentina 0.50%), Canada (0.40-0.50%), Taiwan (0.30%), Singapore (0.30%), Bahamas (0.20%), Honduras (0.10%) and India (0.05%)

the target fund ratio of the 15 countries stood at 1.45 per cent as at December 31, 2007 (IADI, 2009).

The second method for determining the adequacy of DIF is the credit portfolio approach, which seems to be more analytical than the target fund ratio method. The second method for determining the adequacy of DIF is the credit portfolio approach, which seems to be more analytical than the target fund ratio method. Although the method is not very popular amongst IADI member countries, it is being used in countries such as United States of America, Canada, Singapore and Hong Kong (IADI, 2009). Although the method is not very popular amongst IADI member countries, it is being used in countries such as United States of America, Canada, Singapore and Hong Kong (IADI, 2009). As observed by IADI, the portfolio consists of individual exposures to insured banks, each of which has the potential (some greater than others) of causing a loss to the fund. As observed by IADI, the portfolio consists of individual exposures to insured banks, each of which has the potential (some greater than others) of causing a loss to the fund. In most cases, there will be a relatively high probability of small losses and a much lower probability of very large losses. In most cases, there will be a relatively high probability of small losses and a much lower probability of very large losses. The probable large losses would tend to be associated with the presence of large banks (IADI, 2009).

Adopting the credit portfolio approach requires an insurer to consider: developing a specific provision for each member bank taking into account the risk of losses and the range of losses that could occur over a specified period of time; and setting aside additional funds (or surpluses) to cover situations where actual losses, as a result of unexpected factors, may exceed reserves. Adopting the credit portfolio approach requires an insurer to consider: developing a specific provision for each member bank taking into account the risk of losses and the range of losses that could occur over a specified period of