How do deposit guarantee and investor compensation schemes work?

Every bank that has received supervisory authorisation to conduct deposit business and lending business is – by law – automatically a member of a deposit guarantee scheme. Similarly, securities trading firms with the authorisation required to provide investment services are – by law – members of an investor compensation scheme.

Alongside these two forms of statutory compensation, savings banks and cooperative banks have institutional protection schemes that are recognised as deposit guarantee schemes and additional voluntary deposit protection funds also exist.

A common feature of all guarantee schemes and voluntary deposit protection funds is that they are financed by means of annual contributions from their members. If these funds are insufficient, the guarantee schemes collect special contributions from their member institutions or take out loans.

Statutory compensation schemes

In Germany, there are two statutory compensation schemes: the deposit guarantee scheme and the investor compensation scheme.

The Compensation Scheme of German Private Banks (Entschädigungseinrichtung deutscher Banken GmbH (EdB) is a deposit guarantee scheme that protects the customers of banks that are not members of the institutional protection schemes that are described below. If a bank becomes insolvent and BaFin determines that compensation is payable, the statutory compensation scheme generally reimburses deposits up to a certain amount.

Investors that use the investment services of a dedicated securities trading bank (i.e. those without authorisation to operate as full-service banks), of financial services institutions or of asset management companies are protected by the investor compensation scheme. This scheme is the responsibility of the Compensatory Fund of Securities Trading Companies (Entschädigungseinrichtung der Wertpapierhandelsunternehmen (edW)). The EdW pays out compensation if a securities trading firm is no longer capable of meeting its obligations to customers that arise from securities transactions and BaFin has determined that compensation is payable.

Institutional protection schemes of savings banks and credit cooperatives

Customers of public sector savings banks, state banks, state building and loan associations and cooperative banks are protected by institutional protection schemes. In the case of savings banks, this is the responsibility of the guarantee scheme of the German Savings Banks Association (Deutscher Sparkassen- und Giroverband – DSGV). The guarantee scheme of the National Association of German Cooperative Banks (Sicherungseinrichtung des Bundesverbandes der Volksbanken und Raiffeisenbanken – BVR) is responsible in the case of credit unions and other cooperative banks. The purpose of the institutional protection schemes is to prevent the insolvency and liquidation of its member institutions. If an institution experiences financial difficulties, it can be assisted, for example, through the provision of equity or the granting of sureties and guarantees. Merger with another institution can also take place in order to prevent insolvency. The intention here is that it never becomes necessary for any compensation to be paid in relation to member institutions. This means that customers’ deposits are indirectly protected in their entirety.

Furthermore, the institutional protection schemes of the DSGV and the BVR are recognised as statutory deposit guarantee schemes. If, despite such institutional protection, it nevertheless becomes necessary for compensation to be paid out for a member institution of the institutional protection scheme of the DSGV or the BVR, the customers concerned have – as is the case with statutory compensation schemes – a statutory compensation claim.

Additional voluntary deposit protection funds

Alongside the statutory deposit guarantee schemes, the banking associations have set up voluntary deposit guarantee schemes. The Deposit Protection Fund of the Association of German Banks (Einlagensicherungsfonds des Bundesverbandes deutscher Banken e.V. (BdB)) offers the customers of its member institutions the possibility of compensation that goes beyond their legal entitlements. The Deposit Protection Fund of the Association of German Public Banks (Einlagensicherungsfonds des Bundesverbandes der Öffentlichen Banken e.V. (VÖB)) provides additional security to the customers of institutions governed by public law. Neither of these schemes, however, grant any legal entitlement to compensation.

What is protected?

The deposit guarantee scheme protects customer deposits and the investor compensation scheme protects customer receivables that arise from securities transactions.

Legally protected deposits include, for example, account balances, time deposits and savings deposits.

Bearer bonds and order bonds, liabilities arising from participation rights and liabilities arising from own acceptances are not deposits and are therefore not protected.

Securities (for example, shares, certificates, investment fund units) are also not deposits and are not protected by the deposit guarantee scheme. They are nevertheless the property of the customers and the bank or securities trading firm holds such securities in custody on their customers’ behalf. In the event of insolvency, you can therefore demand that the institution surrender your financial instruments or can have your securities account transferred to another institution, provided that the securities are not being used as security for amounts owed (collateral).

Investor compensation schemes protect customer receivables that arise from securities transactions. This includes funds owed to you in connection with securities transactions (e.g. distributions or disposal proceeds). The schemes also protect your claims against your bank for the return of the securities held in custody for you. You are eligible for compensation if an institution has embezzled or misappropriated your securities or funds and is no longer able to return them.

If your insolvent institution has misadvised you, however, the investor compensation schemes will not apply. You will therefore not receive compensation for any lost profits or for losses incurred due to a misguided investment strategy.

To what extent are funds and receivables protected?

The maximum statutory compensation entitlement for deposits is generally €100,000. This figure is the maximum per customer per bank, not per account. In the case of joint accounts, each account holder has a separate claim to compensation. This means that if there are two account holders (e.g. a married couple), the maximum amount from the statutory compensation scheme will double to €200,000. This protection is not limited to deposits in euros and currencies of other EU member states; rather, it extends to deposits in all currencies, including US dollars and Swiss francs.

Under certain circumstances, the maximum amount can increase to as much as €500,000 for a period of six months after deposited amounts are credited – although this can only occur with amounts that relate to the following life events:

• amounts relating to private residential property transactions,
• amounts that serve social purposes stipulated by law and are linked to events such as marriage, divorce, reaching retirement age, retirement, dismissal, redundancy, birth, illness, need for nursing care, invalidity, disability or death,
• amounts relating to the payment of certain insurance benefits,
• compensation payments for injuries caused by criminal violence or damages due to wrongful conviction.

The voluntary deposit guarantee funds increase the amount covered by the deposit guarantee beyond the statutory minimum requirements. This means that the statutory deposit guarantee applies first and covers the maximum amount of €100,000 (or, under certain circumstances, up to €500,000). Only damages in excess of this amount will be compensated by the voluntary deposit guarantee scheme, which is organised under private law. However, no enforceable legal entitlement to this additional protection exists.

Under statutory investor compensation schemes, in the event of loss, you have a claim for 90% of your receivables arising from securities transactions up to the maximum amount of €20,000. A compensation claim exists if the funds are denominated in euros or in the currency of an EU member state.

How are the guarantee schemes supervised?

The statutory compensation schemes (EdB and EdW) and the recognised institutional protection schemes that are organised by the German Savings Banks Association and National Association of German Cooperative Banks are subject to supervision by BaFin. The objective of this supervision is to prevent or remedy irregularities and guarantee that sufficient funds are available to the individual schemes. To this end, BaFin has extensive rights to demand information and conduct audits. BaFin only supervises the voluntary deposit guarantee funds to the extent it relates to the fulfilment of the information obligations that apply to them.

Which guarantee scheme does my bank belong to?

The websites of the guarantee schemes provide information about which banks are member institutions and to what extent your money, receivables and contracts are protected.

Banks and securities trading firms are also legally obliged to provide information on their membership in guarantee schemes within their schedule of fees. Information about membership is usually also provided in the institution’s general terms and conditions (T&Cs). If you are a new customer, your bank must inform you about the scope of the deposit guarantee scheme in writing. Such a requirement also applies if your bank leaves a deposit guarantee scheme. Banks are also obliged to provide customers with a standardised information sheet at least once a year informing them about the scope of the statutory deposit guarantee scheme and the amounts covered.

Are funds held at foreign banks also protected?

Within the European Economic Area (EEA), all states are obliged to protect deposits at banks up to the amount of €100,000. The EEA comprises the member states of the European Union as well as Iceland, Liechtenstein and Norway.

The specific conditions and details of the protection schemes may differ from those in Germany. Customers should therefore contact the competent deposit protection schemes if they have questions about their scope of protection. In particular, there may be differences in how deposits are protected if a trust model is used for making deposits at an institution within the EEA. In such cases, customer deposits are placed into trust accounts. Such accounts are generally held in the name of a bank rather than the name of the depositor.

In non-European countries, there are major differences in the regulations governing deposit guarantees. Outside Europe, it is only possible to obtain authoritative information on the scope of protection from the competent deposit guarantee scheme itself.

Answers to questions about the harmonised European deposit protection system (including information about how they are financed and regarding information obligations for banks) can be found on the website of the German Federal Ministry of Finance.

What happens if a bank is facing insolvency?

If a bank becomes insolvent and BaFin has determined that compensation is payable, the deposit guarantee scheme automatically initiates the compensation process. BaFin usually also applies for the opening of insolvency proceedings with the courts.

If BaFin has determined that compensation is payable, you do not have to make any claim for coverage up to the amount of €100,000 or provide any separate proof. The compensation is paid based on the information available from the bank. Payment must take place within seven working days. There are special requirements for the coverage amount of up to €500,000. In such cases, you must make a written claim and provide proof to substantiate the underlying circumstances.

The investor compensation process also begins once it is determined that compensation is payable and the competent compensation scheme automatically notifies all affected customers of the institution. You can then register your claims with the relevant scheme for compensation for liabilities arising from securities transactions within one year.

The competent guarantee scheme that pays out funds determines whether and in what amounts compensation claims exist.

The voluntary deposit guarantee funds have their own rules on how to proceed should a member institution become insolvent. You can enquire about this with the relevant bank associations.

Overview of protection

• Deposits of up to a maximum of €100,000 per customer per bank
• Deposits relating to certain life events up to a maximum of €500,000 for a period of six months
• Distributions and sales proceeds from securities usually up to 90% of receivables and up to a maximum of €20,000 per customer (exception in the case of banks – see table)

Table 1: Protection of financial products*

Financial product	Protection	Protection via
Current account deposits	Yes	Deposit protection
Savings account deposits	Yes	Deposit protection
Time deposits	Yes	Deposit protection
Customer receivables from securities transactions at a bank if claim relates to a cash payment (e.g. distributions, sales proceeds)	Yes	Deposit protection
Customer receivables from securities transactions at a bank if a claim for the return of securities cannot be met by the bank (e.g. internal banking fraud)	Yes	Investor compensation
Liabilities from securities transactions with a securities trading firm or an asset management company	Yes	Investor compensation
Bearer bonds	No
Order bonds	No
Liabilities from participation rights	No
Liabilities from own acceptances	No

* This list of protected and non-protected financial products is provided as an example. It should be viewed as subject to the specific contractual provisions and relevant entitlements and is not an exhaustive listing.

Bank resolution – a special case

Since 1 January 2015, a resolution regime has been in place for banks facing difficulties. The financial crisis demonstrated that normal insolvency proceedings are not always the best approach for some banks. On the contrary, in the case of banks of systemic importance – such as larger and highly interconnected institutions – insolvency might even exacerbate macroeconomic problems. Some of the assets of such institutions would then have to be sold for less than their value. Moreover, other banks and the real economy could experience knock-on effects from the bank’s plight and find themselves in difficulties of their own if, for example, they have receivables from the bank or rely on its services. Both of these scenarios would result in damages not only for the individual shareholders and creditors, but for the broader economy as well. In the past, this often compelled states to provide banks with assistance at the expense of the public purse.

Resolution instead of insolvency proceedings

For the aforementioned reasons, the European legislature has made it possible for a bank facing difficulties to undergo an orderly resolution rather than normal insolvency proceedings. The intention of such resolutions is to ensure that functions that are critical to the real economy and the financial system can continue being performed and that contagion effects are prevented to the greatest degree possible.

In general, it is only systematically important institutions that undergo resolution (e.g. larger and highly interconnected institutions or institutions that perform critical functions for the real economy and the financial system). The Single Resolution Board (SRB) is the resolution authority for particularly significant institutions and institutions operating on a cross-border basis within the European banking union. In Germany, the SRB works together with BaFin to carry out resolutions. For less significant institutions, this competence is entrusted to national resolution authorities (NRAs). In Germany, BaFin is the national resolution authority.

Special procedures and rules apply in the event of resolution. There are, for instance, four resolution tools: the bridge institution, the asset management company, the sale of business and the bail-in.

Bail-in

A key feature of bail-ins, which consist of writing down and converting relevant capital instruments, is that the taxpayer does not absorb the losses of the bank concerned; rather, its shareholders and creditors share in its losses. The write-down and conversion of relevant capital instruments and the bail-in of creditors is intended to prevent the use of public funds. The objective is to recapitalise the bank so that, for example, its critical functions for the real economy or the financial market can be maintained. As mentioned above, the intention here is to prevent contagion effects spreading to other institutions or the real economy. A bail-in means that an intervention in existing creditor rights takes place. This may only occur if there is a public interest in the resolution. Moreover, no shareholder, holder of relevant capital instruments or creditor may incur greater losses than they would in an insolvency. Covered deposits are also safeguarded in the event of a resolution. The protection provided by the statutory deposit guarantee scheme applies no differently than in cases of insolvency.

Liability: first the shareholders – then creditors

In the event of a resolution, the shareholders of the bank are the first to be held liable. If their share capital is not sufficient, the holders of relevant capital instruments are the next group to be held liable as part of the bail-in. This is followed by creditors with capital investments in the bank. If the bank undergoes resolution, it is therefore possible that private investors will also share in its losses – be they shareholders, holders of relevant capital instruments or creditors.

Creditor’s receivables from the institution are written down in part or in full and/or are transformed into new shares in the bank. The first step here is the absorption of losses that surpass the bank’s capital. To this end, shares in the bank are cancelled and, if necessary, claims are written down. The second step is to raise the new capital that the bank requires to continue conducting business. To this end, further receivables from the bank are converted into holdings in the bank, such as shares. These holdings are given to the creditors whose receivables have been converted.

If the losses of the bank are particularly high, a creditor could, under certain circumstances, lose their receivable from the institution in its entirety – e.g. the repayment claim from a fixed-interest security issued by the bank. This risk nevertheless also exists in the event of insolvency.

Exclusions from bail-ins

As outlined above, covered deposits are subject to special protection should a bail-in take place. Statutory deposit guarantee schemes have protective mechanisms that benefit creditors (see table 2). As is the case with insolvency, deposits of up to €100,000 per depositor eligible for compensation and per bank are generally subject to statutory protection. The maximum amount can also increase to as much as €500,000 in certain cases. These deposits are also excluded from bail-ins. Therefore, deposits of up to this amount held in current or time deposit accounts cannot be drawn upon for the purpose of a bank resolution. Deposits held by natural persons as well as by small and medium-sized enterprises that exceed this amount also enjoy a privileged status within the context of resolution (and insolvency) and are drawn upon as the very last resort for meeting liabilities.

When it comes to securities, a distinction has to be made. If the bank has issued the securities itself, they will not be excluded from a bail-in. However, securities from other issuers that the bank merely holds in custody are excluded from the resolution of the bank concerned because the security holder has a right of separation (Aussonderungsrecht) in such circumstances.

Table 2 provides an overview of the receivables of private investors that are excluded from bail-ins. In such cases, you are a private creditor who bears no liability in the event of a bank resolution.

Table 2: What is excluded from bail-ins for private investors*

Covered deposits	Deposits (including time and notice deposits and savings balances as well as registered bonds and promissory note loans (Schuldscheindarlehen) of up to €100,000 generally and of up to €500,000 in individual cases
Secured liabilities	Covered bonds, in particular Pfandbriefe, secured loans and in certain circumstances derivatives
Customer securities held in custody not issued by the bank	Securities of retail and corporate clients managed or held for investment purposes and not issued by the bank
Liabilities resulting from a fiduciary relationship	Pass-through loans (loans granted on a trust basis, administered loans, transmitted loans)

* Instruments that are excluded from bail-ins but that do not concern private investors are omitted from this table.

Bail-in: no disadvantages compared to insolvency

Bank resolution follows the general principle that no bail-in may result in any shareholder, holder of relevant capital instruments or creditor being treated less favourably in economic terms than would be the case in the event of insolvency proceedings. The loss that a shareholder, holder of relevant capital instruments or creditor incurs due to a bank resolution may not be greater than the loss that would be incurred due to bank insolvency. When determining this, it is nevertheless necessary to take account of the value of the bank shares that the investor receives from the conversion of their receivables. The resolution of the bank generally assists in avoiding the need to sell off its assets for less than their actual value. It can therefore be expected that the losses incurred by creditors in the event of a resolution will actually be lower than in the case of regular insolvency proceedings.

Sequence of a bail-in

If the resolution authority orders a bail-in, it has to use the assets of the shareholders, the receivables of holders of relevant capital instruments and the receivables of creditors in a legally specified bail-in sequence (liability cascade).

The table here provides an overview of how your shares and receivables from the bank would be ranked in the event of a bail-in. It only covers securities issued by German credit institutions themselves as well as their liabilities.

Securities issued by foreign credit institutions are subject to different rules, i.e. those of the country in which the respective institution is domiciled. Anyone who holds such securities should request information from the bank that advised them.

Bail-in sequence based on insolvency hierarchy

How was this bail-in sequence established? As mentioned above, no shareholder, holder of relevant capital instruments or creditor may be treated less favourably in a resolution than they would in an insolvency. In insolvency proceedings, not all creditors are treated equally either and a ranked hierarchy also exists. For example, creditors that have contractually agreed to the subordination of their claims with the bank will only have such claims met and receive payment once the claims of all other creditors have been satisfied. Creditors are usually granted a higher interest rate in return for such subordination. If creditors do not receive payment for subordinated claims until a later stage in the sequence applied in the event of an insolvency, such receivables must conversely be used at an earlier stage in the context of a bail-in. Therefore, the sequence in which creditors participate in a bail-in is an inversion of the sequence in which their claims would be met in the event of an insolvency.

Therefore, the creditor claims that would be met last in the event of an insolvency are the first to be reduced in part or to zero in the event of a bail-in. If this is not sufficient to raise the funds required for the resolution, the receivables of the next rank of creditors are written down. Within each individual rank, however, all creditors bear an equal degree of losses.