The optimal level of deposit insurance coverage
AbstractThis paper develops a global game model that allows for a rigorous analysis of partial deposit insurance and provides the first comparative statics of the optimal level of deposit coverage. The optimal amount of coverage increases with lower bank liquidity requirements, with a higher precision of depositors' information, and with a lower relevance of large, uninsured creditors, and it should not be increased in anticipation of an economic downturn. Optimal insurance is higher if there is contagion and lower if banks can assume excessive risk, but interestingly, a high level of coverage may not be optimal even in the absence of moral hazard on the part of banks. The model supports the inauguration of coinsurance provisions and is applied to compare various policies addressing financial fragility. While an optimal lending of last resort policy can outperform deposit insurance, anticipated bailouts are inferior in terms of welfare. Capital requirements are not a substitute for insurance, but mitigate excessive risk taking.
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Bibliographic InfoPaper provided by Federal Reserve Bank of Boston in its series Working Papers with number 09-6.
Date of creation: 2009
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-07-28 (All new papers)
- NEP-BAN-2009-07-28 (Banking)
- NEP-CBA-2009-07-28 (Central Banking)
- NEP-CTA-2009-07-28 (Contract Theory & Applications)
- NEP-IAS-2009-07-28 (Insurance Economics)
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- Li, Gan & Wen-Yao, Wang, 2010. "Partial Deposit Insurance and Moral Hazard in Banking," MPRA Paper 25798, University Library of Munich, Germany.
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