Financial institutions are legal persons with a permission to engage in financial activities with third parties. Permission is granted by a regulator. The rules under which the institution is allowed to operate depend on the proposed activities, the assumed customers and the associated risk profile. Economic volatility, fluctuations in public confidence, and distressed bank situations are ongoing concerns. As a result, regulators adopt several ways to control the functioning of individual banks under their supervision.
Non-systemic banks and privately owned financial institutions play an important but not crucial role in society. Their failure is handled via local regulation. Failure of financial institutions may result in a continuation of activities under different ownership, or by termination and winding up of the company. But first, it must be determined whether the bank engaged in illicit activities or that failure is the result of internal financial challenges.
Although the structure of banking and finance these days is merely based on trust and market confidence, not all financial institutions are at risk. Economic growth relies for a large part on private and commercial borrowing. Fractional reserve lending allows financial institutions to lend out more money than they hold at their accounts. In times of economic decline, this system can trigger a downward spiral. Financial institutions must therefore be monitored closely to avoid systemic difficulties.
Banks that fail are initially placed under statutory administration. The management of the bank is replaced with a special administrator who investigates the internal organization and formulates a resolution plan. If matters take too long and there is little view on a solution, deposit insurance can be triggered. The submission of a deposit guarantee claim follows a strict protocol. Not every account balance and creditor qualifies for such insurance. Therefore, account holders must secure a clear understanding of the rules under which claim submissions take place and repayment is honored.
The intention of deposit insurance is to avoid damage to and disruption of a local payment system. Based on this policy objective, regulators require licensed and supervised financial institutions to participate in domestic deposit protection schemes. These schemes are tailored towards the local market and can therefore vary from each other. Bank account holders are therefore urged to closely examine the applicable regulation to ensure maximum repayment against minimum risk.