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The benefits of deposit protection accrue to both depositors and banking institutions through enhancement of financial stability.

Benefits to the financial sector: (a) Promote financial stability

By insuring the deposits, a Deposit Protection Scheme (DPS) fosters confidence in the banking system, prevents self-fulfilling panics or bank runs thereby reducing the likelihood of contagion and cascading defaults. A DPS reduces financial uncertainty, thereby promoting financial intermediation and enhancing economic and financial stability.

(b) Competition: A Deposit Protection Scheme levels the playing field. Larger banks due to their size, track record and brand visibility have an edge over smaller contributory institutions in attracting deposits at lower interest rates. A DPS makes depositors of smaller banks feel safe and protected hence neutralise the advantages.

(c) Liquidity: Some Deposit Protection Schemes have mandates and resources that enable them to inject capital in distressed contributory institutions to avert bank failures.

(d) Complementary financial safety nets and regulatory discipline: Establishment of deposit protection agencies with wide mandates such as risk minimisation or loss minimisation complements the supervisory and regulatory framework via carrying out onsite, offsite and special examinations at contributory institutions. This is not duplication of effort as there is demonstrable evidence in some jurisdictions that such arrangements enhance alertness of the safety net players in several ways including: eliminating existence of a single point of failure; enhanced regulatory objectivity, accountability and transparency; and reduced opportunities for regulatory arbitrage, failure or capture.

Benefits to depositors: (a) Peace of mind

Depositors are guaranteed reimbursement in event of insolvency. A DPS reduces financial uncertainty and builds confidence.

(b) Free membership: No direct charge to depositors as banks pay the premiums. Depositors do not apply or complete application forms, as deposit protection is automatic once a depositor opens an account with member bank.

(c) Financial inclusion: Promotes inclusivity — establishment of a DPS catering for both individual and well to do corporate clients, as opposed to a Scheme for small depositors alone, also reduces incidences of deliberate financial exclusion.

(d) Minimise losses and protecting majority of depositors: DPS helps to minimise losses to small depositors (the majority) who are most affected by bank closures, and lack resources and skills to monitor contributory institutions. Effectiveness of DPS depends on the coverage level that is percentage of depositors with deposits equal or below the protection limit. Best practice requires that 90 percent of depositors (by number) should be covered in full.

(e) Public awareness: This is an important objective: When a bank fails, a DPS informs depositors on how and when reimbursement will be made. Banks have a legal obligation to inform depositors regarding the nature & extent of coverage.

(f) Prompt and orderly exit of failed contributory institutions: A resolution mandate provides orderly exit for failed banks; prompt refund; and protects interests of large depositors and creditors via the liquidation process.