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Is Deposit Insurance a Good Thing, and If So, Who Should Pay for It?

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  • Alan Morrison
  • Lucy White
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    Abstract

    Deposit insurance schemes are becoming increasingly popular around the world and yet there is little understanding of how they should be designed and what their consequences are. In this paper we provide a new rationale for the provision of deposit insurance. We analyse a model in which agents choose between depositing their funds with banks and placing them in a less productive self-managed project. Bankers have valuable but costly project management skills and the banking sector exhibits both adverse selection and moral hazard. Depositors do not fully account for the social benefits accruing from bank management of projects and so too few deposits are made in equilibrium. The regulator can correct this market failure by providing deposit insurance to encourage deposits. Contrary to received opinion, we find that deposit insurance should be funded not by bankers or depositors but through general taxation.

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    Bibliographic Info

    Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 2004-FE-08.

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    Date of creation: 01 Mar 2004
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    Handle: RePEc:oxf:wpaper:2004-fe-08

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    Cited by:
    1. Claeys, Sophie, 2005. "Optimal regulatory design for the Central Bank of Russia," BOFIT Discussion Papers 7/2005, Bank of Finland, Institute for Economies in Transition.
    2. Klüh, Ulrich, 2005. "Safety Net Design and Systemic Risk: New Empirical Evidence," Discussion Papers in Economics 662, University of Munich, Department of Economics.

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