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Deposit Insurance and Moral Hazard: Capital, Risk, Malfeasance, and Mismanagement

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  • Gary Richardson

Abstract

Hooks and Robinson (2002) argue that deposit insurance in Texas during the 1920s induced banks to invest in riskier assets. Their regressions indicate that this manifestation of moral hazard may explain some of what happened, but not all. Some other mechanism, hitherto overlooked, must also have been at work. A more complete interpretation of what happened recognizes that deposit insurance induced moral hazard of many types. Depositors grew lax in monitoring the safety and soundness of banks. Bankers took advantage of the lack of supervision and advanced their own interests – via malfeasance or mismanagement – at depositors’ expense. Bankers reduced reserve holdings and operated with lower levels of capital. All of these manifestations of moral hazard are consistent with the Hooks’ and Robinson’s regressions. Data drawn from the archives of the Board of Governors highlights the role of malfeasance and mismanagement. In sum, many manifestations of moral hazard afflicted banks in Texas during the 1920s.

Suggested Citation

  • Gary Richardson, 2007. "Deposit Insurance and Moral Hazard: Capital, Risk, Malfeasance, and Mismanagement," Econ Journal Watch, Econ Journal Watch, vol. 4(3), pages 296-302, September.
  • Handle: RePEc:ejw:journl:v:4:y:2007:i:3:p:296-302
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    References listed on IDEAS

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    1. Merton, Robert C., 1977. "An analytic derivation of the cost of deposit insurance and loan guarantees An application of modern option pricing theory," Journal of Banking & Finance, Elsevier, vol. 1(1), pages 3-11, June.
    2. Hooks, Linda M. & Robinson, Kenneth J., 2002. "Deposit Insurance And Moral Hazard: Evidence From Texas Banking In The 1920s," The Journal of Economic History, Cambridge University Press, vol. 62(03), pages 833-853, September.
    3. Ching-Yi Chung & Gary Richardson, 2006. "Deposit Insurance and the Composition of Bank Suspensions in Developing Economies: Lessons from the State Deposit Insurance Experiments of the 1920S," NBER Working Papers 12594, National Bureau of Economic Research, Inc.
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    More about this item

    Keywords

    Deposit insurance; moral hazard; defalcation; mismanagement; bank failure;

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance
    • N2 - Economic History - - Financial Markets and Institutions
    • N22 - Economic History - - Financial Markets and Institutions - - - U.S.; Canada: 1913-

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