Sri Lanka urged to go for a deposit insurance scheme

Dec 19, 2007 (LBO) – Sri Lanka should introduce a compulsory deposit insurance scheme to strengthen the banking system and provide a public safety net, the International Monetary Fund has said. "The existing voluntary scheme is not used, and the fact that the one bank to have failed in the past few decades had been bailed out at the behest of the government has created an expectation of a blanket guarantee," IMF said in a financial sector assessment report on Sri Lanka.

But the IMF suggested the Central Bank should not introduce deposit insurance until preconditions for effective banking supervision are in place.

The introduction of the scheme should be timed when all banks are able to meet regulatory capital requirements, risk-focused supervision has been effectively implemented, and supervisory independence is assured, the IMF said in a new assessment of the island's financial system stability.

"There are a high number of small depositors in the system, and introduction of a credible deposit insurance scheme could lessen the moral hazard," it said.

The moral hazard of deposit insurance is that depositors will go for riskier banks with high interest because of the insurance