What the principle limits
The least-cost principle is a spending ceiling that governs how far a deposit guarantee scheme (DGS) may go beyond its core task of repaying covered depositors. A DGS may be called upon in three distinct situations: to reimburse covered deposits when a bank is wound up; to finance resolution when covered deposits are transferred or otherwise protected; or, where national law permits, to fund preventive measures that keep a bank viable or alternative measures that facilitate an orderly exit. In each of the latter cases, the scheme's contribution may not exceed what it would have cost the DGS to reimburse covered depositors in ordinary insolvency proceedings.
The cap is calculated on a net basis. From the gross payout the DGS would have faced, the calculation deducts the amount the scheme would expect to recover from the insolvency estate, because as a preferred creditor the DGS is subrogated to the depositors' claims and ranks high in the creditor hierarchy. The result is the counterfactual against which any resolution contribution or preventive spend is measured.
How it works in practice
When a bank enters resolution and its covered deposits are transferred to a purchaser or bridge institution, the DGS may be required to contribute in place of the covered depositors, who are not bailed in. The least-cost test ensures that this contribution does not turn the scheme into an open-ended funder of resolution: it can be asked to give no more than depositors' protection would have cost in liquidation. The same discipline applies where a scheme uses its funds preventively to support a bank before failure.
This ceiling interacts closely with the no-creditor-worse-off safeguard. Covered depositors themselves must end up no worse than in insolvency, and the DGS that stands behind them is limited to the same insolvency counterfactual. Both are anchored in the hypothetical liquidation valuation prepared for the case.
Legal basis
The principle is set out in the Deposit Guarantee Schemes Directive, Article 11, which frames the use of DGS funds for resolution and for preventive and alternative measures and imposes the least-cost limit, and in the resolution framework itself through the BRRD, Article 109, which governs the DGS contribution when covered deposits are involved in resolution and caps it by reference to the insolvency counterfactual. The recovery due to the scheme under the creditor hierarchy follows from the BRRD, Article 108.
Practical relevance for banks and investors
For resolution authorities, the least-cost principle constrains how much of a transfer or bail-in shortfall can be shifted onto the DGS, and therefore influences whether a resolution strategy is affordable and how much loss must fall on other creditors. For investors in a bank's liabilities, it matters because DGS money that is capped tends to preserve the burden on bailed-in creditors rather than displace it. For the schemes and their member banks, the principle protects the fund from being depleted below the level needed for its primary reimbursement duty.