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The Defective Design Of Federal Deposit Insurance

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  • KENNETH E. SCOTT

Abstract

Deposit insurance funds, especially the Federal Savings and Loan Insurance Corporation, are currently in visible trouble. Two central defects of the existing deposit insurance system are identified: (1) mispricing of the insurance premiums and (2) incentives for both the industry and the insurance agencies to postpone recognizing and realizing losses. Insurance premiums are mispriced because they are assessed at the same rate for all institutions, which creates a bias for banks to take greater risks. Practical difficulties of setting an appropriate risk‐based premium for each bank are real but not necessarily insurmountable. In particular, the sale by the bank of unsecured and uninsured debt could provide a market measure of default risk, under a given failure rule. The choice of a failure rule is also a critical matter. Current failure rules are poorly defined and permit insolvent institutions to continue in operation. Specifying a market value test of insolvency in the statutes would be helpful, but it would have to be supported by market‐value accounting requirements and stronger pressures on banking authorities not to defer action.

Suggested Citation

  • Kenneth E. Scott, 1987. "The Defective Design Of Federal Deposit Insurance," Contemporary Economic Policy, Western Economic Association International, vol. 5(1), pages 92-99, January.
    • Handle: RePEc:bla:coecpo:v:5:y:1987:i:1:p:92-99
    DOI: 10.1111/j.1465-7287.1987.tb00249.x
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    References listed on IDEAS

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    1. James R. Barth & R. Dan Brumbaugh, Jr. & Daniel Sauerhaft & George H. K. Wang, 1985. "Insolvency And Risk‐Taking In The Thrift Industry: Implications For The Future," Contemporary Economic Policy, Western Economic Association International, vol. 3(5), pages 1-32, September.
    2. Edward J. Kane, 1985. "The Gathering Crisis in Federal Deposit Insurance," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262611856, December.
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