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Discount Window Lending and Deposit Insurance

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  • Stephen D. Williamson

    (Department of Economics, University of Iowa)

Abstract

A banking model is constructed where roles for government-provided deposit insurance and discount window lending arise when there are restrictions on branch banking. Banks arise endogenously as an efficient arrangement for sharing risk. Discount window lending permits better risk-sharing by making bank assets more liquid, but is limited because of a moral hazard problem which arises from adverse selection in the loan market. Deposit insurance also creates the potential for better risk-sharing, but accomplishes this through contingent transfers rather than enhancing liquidity. Banks tend to take on more risk with deposit insurance and to take less care in screening loans, but this is consistent with an increase in welfare for depositors and borrowers. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1006/redy.1997.0002
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 1 (1998)
Issue (Month): 1 (January)
Pages: 246-275

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Handle: RePEc:red:issued:v:1:y:1998:i:1:p:246-275

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References

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  1. John H. Boyd & Mark Gertler, 1993. "U.S. Commercial Banking: Trends, Cycles, and Policy," NBER Working Papers 4404, National Bureau of Economic Research, Inc.
  2. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
  3. Hornstein, Andreas & Krusell, Per, 1993. "Money and Insurance in a Turnpike Environment," Economic Theory, Springer, vol. 3(1), pages 19-34, January.
  4. Kareken, John H & Wallace, Neil, 1978. "Deposit Insurance and Bank Regulation: A Partial-Equilibrium Exposition," The Journal of Business, University of Chicago Press, vol. 51(3), pages 413-38, July.
  5. Townsend, Robert M, 1987. "Economic Organization with Limited Communication," American Economic Review, American Economic Association, vol. 77(5), pages 954-71, December.
  6. Cheng Wang & Stephen D. Williamson, 1993. "Adverse Selection in Credit Markets with Costly Screening," Finance 9310001, EconWPA, revised 02 Nov 1993.
  7. John H. Boyd & Arthur J. Rolnick, 1988. "A case for reforming federal deposit insurance," Annual Report, Federal Reserve Bank of Minneapolis.
  8. Stephen D. Williamson, 1989. "Restrictions on Financial Intermediaries and Implications for Aggregate Fluctuations: Canada and the United States 1870-1913," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 303-350 National Bureau of Economic Research, Inc.
  9. Mitsui, Toshihide & Watanabe, Shinichi, 1989. "Monetary growth in a turnpike environment," Journal of Monetary Economics, Elsevier, vol. 24(1), pages 123-137, July.
  10. Champ, B. & Snith, B.D. & Williamson, D.S., 1991. "Currency Elasticity and Banking Panics: Theory and Evidence," RCER Working Papers 292, University of Rochester - Center for Economic Research (RCER).
  11. Neil Wallace, 1988. "Another attempt to explain an illiquid banking system: the Diamond and Dybvig model with sequential service taken seriously," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 3-16.
  12. Cheng Wang & Stephen D. Williamson, 1998. "Debt Contracts with Financial Intermediation with Costly Screening," Canadian Journal of Economics, Canadian Economics Association, vol. 31(3), pages 573-595, August.
  13. English, William B., 1993. "The decline of private deposit insurance in the United States," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 38(1), pages 57-128, June.
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Cited by:
  1. Roberto Chang & Andres Velasco, 1998. "Financial Fragility and the Exchange Rate Regime," NBER Working Papers 6469, National Bureau of Economic Research, Inc.
  2. Marshall, David A. & Prescott, Edward Simpson, 2001. "Bank capital regulation with and without state-contingent penalties," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 54(1), pages 139-184, June.
  3. Schreft, Stacey L. & Smith, Bruce D., 2000. "The evolution of cash transactions: Some implications for monetary policy," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 97-120, August.
  4. Sophio Khundadze, 2010. "Expected Effect of Deposit Insurance System Over the State of the Banking Environment of Georgia," IBSU Scientific Journal, International Black Sea University, vol. 4(2), pages 53-72.
  5. Antinolfi, Gaetano & Huybens, Elisabeth & Keister, Todd, 2001. "Monetary Stability and Liquidity Crises: The Role of the Lender of Last Resort," Journal of Economic Theory, Elsevier, vol. 99(1-2), pages 187-219, July.
  6. Kawamura, Enrique, 2007. "Exchange rate regimes, banking and the non-tradable sector," Journal of Monetary Economics, Elsevier, vol. 54(2), pages 325-345, March.
  7. Antoine Martin, 2006. "Liquidity provision vs. deposit insurance: preventing bank panics without moral hazard," Economic Theory, Springer, vol. 28(1), pages 197-211, 05.
  8. Antoine Martin, 2008. "Reconciling Bagehot with the Fed's response to September 11," Staff Reports 217, Federal Reserve Bank of New York.
  9. Gaetano Antinolfi & Todd Keister, 2000. "Liquidity Crises and Discount Window Lending: Theory and Implications for the Dollarization Debate," Working Papers 0002, Centro de Investigacion Economica, ITAM.
  10. Gaetano Antinolfi & Todd Keister, 2003. "Discount Window Policy, Banking Crises, and Indeterminacy of Equilibrium," Working Papers 0305, Centro de Investigacion Economica, ITAM.
  11. Enrique L. Kawamura, 2004. "Exchange Rate Regimes, Monetary Policy and Banking Performance in Economies with Cash Constraints. Chang and Velasco Revisited," Working Papers 66, Universidad de San Andres, Departamento de Economia, revised Jan 2004.
  12. Antoine Martin, 2002. "Reconciling Bagehot with the Fed's response to Sept. 11," Research Working Paper RWP 02-10, Federal Reserve Bank of Kansas City.
  13. Bruce D. Smith & Cheng Wang, 1997. "Repeated insurance relationships in a costly state verification model: with an application to deposit insurance," Working Papers 574, Federal Reserve Bank of Minneapolis.
  14. Enrique L. Kawamura, 2003. "Diamond-Dybvig Banks in Two-Good, Two-Currencies, Small Open Economies with Cash-in-Advance Constraints," Working Papers 57, Universidad de San Andres, Departamento de Economia, revised Jan 2004.

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