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

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  • Alan D. Morrison
  • Lucy White

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 Oxford Financial Research Centre in its series OFRC Working Papers Series with number 2004fe08.

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Date of creation: 2004
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Handle: RePEc:sbs:wpsefe:2004fe08

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Cited by:
  1. Franklin Allen & Elena Carletti & Robert Marquez, 2009. "Credit Market Competition and Capital Regulation," Economics Working Papers ECO2009/08, European University Institute.
  2. Klüh, Ulrich, 2005. "Safety Net Design and Systemic Risk: New Empirical Evidence," Discussion Papers in Economics 662, University of Munich, Department of Economics.
  3. Morrison, Alan D. & White, Lucy, 2010. "Reputational contagion and optimal regulatory forbearance," Working Paper Series 1196, European Central Bank.
  4. Veronika Holá & Petr Jakubík, 2011. "Impact of Parametric Changes in Deposit Insurance Schemes in 2008," Politická ekonomie, University of Economics, Prague, vol. 2011(5), pages 659-679.
  5. Morrison, Alan & White, Lucy, 2005. "Level Playing Fields in International Financial Regulation," CEPR Discussion Papers 5247, C.E.P.R. Discussion Papers.
  6. Stefan Arping, 2009. "The Pricing of Bank Debt Guarantees," Tinbergen Institute Discussion Papers 09-057/2, Tinbergen Institute.
  7. Franklin Allen & Elena Carletti & Agnese Leonello, 2011. "Deposit insurance and risk taking," Oxford Review of Economic Policy, Oxford University Press, vol. 27(3), pages 464-478.
  8. Stefan Arping, 2009. "The Pricing of Bank Debt Guarantees," Tinbergen Institute Discussion Papers 09-057/2, Tinbergen Institute.
  9. 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.

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