Deposit Insurance and Risk Management of the U.S. Banking System: How Much? How Safe? Who Pays?
AbstractWe examine the question of deposit insurance through the lens of risk management by addressing three key issues: 1) how big should the fund be; 2) how should coverage be priced; and 3) who pays in the event of loss. We propose a risk-based premium system that is explicitly based on the loss distribution faced by the FDIC. The loss distribution can be used to determine the appropriate level of fund adequacy and reserving in terms of a stated confidence interval and to identify risk-based pricing options. We explicitly estimate that distribution using two different approaches and find that reserves are sufficient to cover roughly 99.85% of the loss distribution corresponding to about a BBB+ rating. We then identify three risk-sharing alternatives addressing who is responsible for funding losses in different parts of the loss distribution. We show in an example that expected loss based pricing, while appropriately penalizing riskier banks, also penalizes smaller banks. By contrast, unexpected loss contribution based pricing significantly penalizes very large banks because large exposures contribute disproportionately to overall (FDIC) portfolio risk.
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Bibliographic InfoPaper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 02-02.
Date of creation: Apr 2002
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Deposit insurance pricing; loss distribution; risk-based premiums.;
Find related papers by JEL classification:
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2002-04-15 (All new papers)
- NEP-IAS-2002-04-15 (Insurance Economics)
- NEP-IFN-2002-04-15 (International Finance)
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