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Challenges Associated with the Expansion of Deposit Insurance Coverage during Fall 2008

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  • Schich, Sebastian T.
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    Abstract

    Government provision of a financial safety net for financial institutions has been a key element of the policy response to the current crisis, with governments extending existing guarantees and introducing new ones. These measures have been helpful in avoiding a further accelerated loss of confidence. But they are not costless. Like any guarantee, deposit insurance gives rise to moral hazard, especially if the coverage is unlimited. In the midst of a crisis, the immediate task is to restore confidence, and guarantees can be helpful in that respect. Nonetheless, to keep market discipline operational, it is important to specify when the extra insurance will end, and this timeline needs to be credible. To be able to establish such a timeline the root causes of the lack of confidence - that is the effects of troubled assets on financial firms' health - need to be addressed effectively. On a more fundamental level, once a government has ventured down the road of guarantee expansion, there may be a general perception that a government guarantee will always be available during crisis situations. As a consequence, other elements of the financial safety net may need to be strengthened, including the prudential and supervisory framework. --

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    File URL: http://dx.doi.org/10.5018/economics-ejournal.ja.2009-20
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    Bibliographic Info

    Article provided by Kiel Institute for the World Economy in its journal Economics: The Open-Access, Open-Assessment E-Journal.

    Volume (Year): 3 (2009)
    Issue (Month): 20 ()
    Pages: 1-23

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    Handle: RePEc:zbw:ifweej:7605

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    Keywords: Policy responses to financial crisis; safety net; deposit insurance; moral hazard;

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    References

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    1. Reinhart, Carmen & Rogoff, Kenneth, 2009. "The Aftermath of Financial Crises," CEPR Discussion Papers 7209, C.E.P.R. Discussion Papers.
    2. Stephen Lumpkin, 2008. "Resolutions of weak institutions: Lessons learned from previous crises," OECD Journal: Financial Market Trends, OECD Publishing, vol. 2008(2), pages 1-42.
    3. Luc Laeven & Fabian Valencia, 2008. "The Use of Blanket Guarantees in Banking Crises," IMF Working Papers 08/250, International Monetary Fund.
    4. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, MIT Press, vol. 125(1), pages 307-362, February.
    5. Demirguc-Kunt, Asli & Detragiache, Enrica, 2002. "Does deposit insurance increase banking system stability? An empirical investigation," Journal of Monetary Economics, Elsevier, vol. 49(7), pages 1373-1406, October.
    6. Reinhart, Carmen M. & Rogoff, Kenneth S., 2009. "The Aftermath of Financial Crises," Scholarly Articles 11129155, Harvard University Department of Economics.
    7. Sebastian Schich, 2008. "Financial turbulence: Some lessons regarding deposit insurance," OECD Journal: Financial Market Trends, OECD Publishing, vol. 2008(1), pages 55-79.
    8. Fabian Valencia & Luc Laeven, 2008. "Systemic Banking Crises," IMF Working Papers 08/224, International Monetary Fund.
    9. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
    10. Kane, Edward J. & Klingebiel, Daniela, 2004. "Alternatives to blanket guarantees for containing a systemic crisis," Journal of Financial Stability, Elsevier, vol. 1(1), pages 31-63, September.
    11. Enrique G. Mendoza & Marco E. Terrones, 2008. "An Anatomy Of Credit Booms: Evidence From Macro Aggregates And Micro Data," NBER Working Papers 14049, National Bureau of Economic Research, Inc.
    12. Deniz Igan & Natalia T. Tamirisa, 2008. "Are Weak Banks Leading Credit Booms? Evidence From Emerging Europe," IMF Working Papers 08/219, International Monetary Fund.
    13. Sebastian Schich, 2008. "Financial crisis: Deposit insurance and related financial safety net aspects," OECD Journal: Financial Market Trends, OECD Publishing, vol. 2008(2), pages 1-39.
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    Cited by:
    1. Beat Bernet & Susanna Walter, 2009. "Design, Structure and Implementation of a Modern Deposit Insurance Scheme," SUERF Studies, SUERF - The European Money and Finance Forum, number 2009/5 edited by Morten Balling.

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