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Fairly Priced Deposit Insurance, Incentive Compatible Regulations, and Bank Asset Choices

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  • Suk Heun Yoon

    (Coal Central Building, Korea Institute of Finance, Fifth Floor, 80.6 Soosong-dong, Chongro-ku 110-140 Seoul Korea)

  • Sumon C. Mazumdar

    (Faculty of Management, McGill University, 1001 Sherbrooke St. West, H3A 1G5 Montreal, Quebec, Canada)

Abstract

This article provides incentive compatible regulations that support fairly priced deposit insurance in a competitive banking industry. If informational asymmetry exists between the regulator and banks regarding loan quality, but the regulator can observe actual loan rates charged, then imposing a capital requirement schedule that leads market loan rates to decrease in loan quality is shown to be incentive compatible. Competition in the loan market induces banks to be indifferent to all loans that satisfy a minimum acceptable quality and reject all riskier loans. The regulator could reduce the banking industry's riskiness by imposing stricter capital requirements that increase this minimum quality. The Geneva Papers on Risk and Insurance Theory (1996) 21, 123–141. doi:10.1007/BF00949053

Suggested Citation

  • Suk Heun Yoon & Sumon C. Mazumdar, 1996. "Fairly Priced Deposit Insurance, Incentive Compatible Regulations, and Bank Asset Choices," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 21(1), pages 123-141, June.
    • Handle: RePEc:pal:genrir:v:21:y:1996:i:1:p:123-141
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    Cited by:

    1. Sanjay Banerji & Andrew Chen & Sumon Mazumdar, 2002. "Universal Banking Under Bilateral Information Asymmetry," Journal of Financial Services Research, Springer;Western Finance Association, vol. 22(3), pages 169-187, December.

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