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Stealing Deposits: Deposit Insurance, Risk‐Taking, and the Removal of Market Discipline in Early 20th‐Century Banks

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  • CHARLES W. CALOMIRIS
  • MATTHEW JAREMSKI

Abstract

Deposit insurance reduces liquidity risk but can increase insolvency risk by encouraging reckless behavior. Several U.S. states installed deposit insurance laws before the creation of the Federal Deposit Insurance Corporation, and those laws applied only to some depository institutions within those states. These experiments present a unique testing ground for investigating the effect of deposit insurance. We show that deposit insurance removed market discipline constraining uninsured banks. Taking advantage of World War I's rise in world agricultural prices, insured banks increased their insolvency risk and competed aggressively for deposits. When prices fell after the war, the insurance systems collapsed and suffered high losses.

Suggested Citation

  • Charles W. Calomiris & Matthew Jaremski, 2019. "Stealing Deposits: Deposit Insurance, Risk‐Taking, and the Removal of Market Discipline in Early 20th‐Century Banks," Journal of Finance, American Finance Association, vol. 74(2), pages 711-754, April.
  • Handle: RePEc:bla:jfinan:v:74:y:2019:i:2:p:711-754
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    File URL: https://doi.org/10.1111/jofi.12753
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    Cited by:

    1. Anderson, Haelim & Barth, Daniel & Choi, Dong Beom, 2018. "Reducing moral hazard at the expense of market discipline: the effectiveness of double liability before and during the Great Depression," Staff Reports 869, Federal Reserve Bank of New York.
    2. Carmassi, Jacopo & Dobkowitz, Sonja & Evrard, Johanne & Parisi, Laura & Silva, André & Wedow, Michael, 2018. "Completing the Banking Union with a European Deposit Insurance Scheme: who is afraid of cross-subsidisation?," Occasional Paper Series 208, European Central Bank.
    3. Ernest Dautovic, 2019. "Has Regulatory Capital Made Banks Safer? Skin in the Game vs Moral Hazard," Cahiers de Recherches Economiques du Département d'économie 19.03, Université de Lausanne, Faculté des HEC, Département d’économie.
    4. Charles W. Calomiris & Sophia Chen, 2018. "The Spread of Deposit Insurance and the Global Rise in Bank Asset Risk since the 1970s," Working Papers id:12909, eSocialSciences.
    5. Jaremski, Matthew & Wheelock, David C., 2017. "Banking on the Boom, Tripped by the Bust: Banks and the World War I Agricultural Price Shock," Working Papers 2017-36, Federal Reserve Bank of St. Louis, revised 26 Jun 2019.
    6. Charles W. Calomiris & Matthew Jaremski, 2016. "Deposit Insurance: Theories and Facts," Annual Review of Financial Economics, Annual Reviews, vol. 8(1), pages 97-120, October.
    7. Damar, H. Evren & Gropp, Reint & Mordel, Adi, 2019. "Flight from safety: How a change to the deposit insurance limit affects households' portfolio allocation," IWH Discussion Papers 19/2019, Halle Institute for Economic Research (IWH).
    8. Haelim Park Anderson & Gary Richardson & Brian S. Yang, 2017. "Deposit Insurance and Depositor Monitoring: Quasi-Experimental Evidence from the Creation of the Federal Deposit Insurance Corporation," NBER Working Papers 23828, National Bureau of Economic Research, Inc.
    9. Calomiris, Charles W. & Flandreau, Marc & Laeven, Luc, 2016. "Political foundations of the lender of last resort: A global historical narrative," Journal of Financial Intermediation, Elsevier, vol. 28(C), pages 48-65.
    10. Linda Schilling, 2018. "Optimal Forbearance of Bank Resolution," Working Papers 2018-15, Becker Friedman Institute for Research In Economics.
    11. Kristian Blickle, 2017. "Local Banks, Credit Supply, and House Prices," Working Papers on Finance 1811, University of St. Gallen, School of Finance.
    12. H. Evren Damar & Reint Gropp & Adi Mordel, 2019. "Flight from Safety: How a Change to the Deposit Insurance Limit Affects Households’ Portfolio Allocation," Staff Working Papers 19-29, Bank of Canada.
    13. Carletti, Elena & De Marco, Filippo & Ioannidou, Vasso & Sette, Enrico, 2019. "Banks as Patient Lenders: Evidence from a Tax Reform," CEPR Discussion Papers 13722, C.E.P.R. Discussion Papers.

    More about this item

    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
    • N22 - Economic History - - Financial Markets and Institutions - - - U.S.; Canada: 1913-

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