February 2005

This paper examines the potential weaknesses of Croatia’s existing deposit insurance system. The major weaknesses of the system lie in design elements that prevent it from dealing adequately with moral hazard problems. Drawing on the positive experiences of numerous other countries and the EU Directive on deposit-guarantee schemes, this paper suggests ways to improve the existing system, devoting special attention to mitigating the moral hazard problem. The paper also discusses possible ways to neutralise two remaining problems: adverse selection and the principal-agent conflicts. It points out some further features of the deposit insurance system that will need to be modified to align Croatia’s system with EU legislation. Finally, the paper also discusses timing issues in implementing the changes suggested.

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