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Reforming Deposit Insurance: The Case to Replace FDIC Protection with Self-Insurance

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  • Panos Konstas
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    Abstract

    The Federal Deposit Insurance Corporation (FDIC) currently insures bank deposit balances up to $100,000. According to some observers, statutory protection creates moral hazard problems for insurers because it allows banks to engage in risky activities. As an example, moral hazard was a key contributor to huge losses suffered when thrift institutions failed during the 1980s. This brief by Konstas outlines a plan to reduce the risk of government losses by replacing insured deposits with uninsured deposits and eliminating some of the costs of deposit insurance. His plan proposes a self-insured (SI) depositor system that places an intermediary between the lender (saver) and borrower (bank) in the credit-flow chain. The FDIC would guarantee saver loans and allow the intermediary to borrow at the risk-free interest rate if the intermediaryÕs bank deposit is statutorily defined outside the realm of FDIC insurance. The risk is therefore transferred to depositors (intermediaries); thus creating incentives for depositors to earn a rate of return at least equal to the cost of borrowing plus a risk premium based on the risk profile of banks.

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    Paper provided by Levy Economics Institute in its series Economics Public Policy Brief Archive with number ppb_83.

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    Date of creation: Jan 2006
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    Handle: RePEc:lev:levppb:ppb_83

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    1. Catharine Lemieux, 1993. "FDICIA : where did it come from and where will it take us?," Financial Industry Perspectives, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Kansas City, issue Nov, pages 1-13.
    2. George J. Benston & George G. Kaufman, 1997. "FDICIA after Five Years," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 11(3), pages 139-158, Summer.
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