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Adverse Selection and Competing Deposit Insurance Systems in Pre-Depression Texas

  • Jeffery Gunther
  • Linda Hooks
  • Kenneth Robinson

In 1910, Texas instituted a highly unique deposit insurance program for its state chartered banks consisting of two separate plans: the depositors guaranty fund, similar in operation to the deposit insurance schemes adopted in several other states; and the depositors bond security system, which required the procurement of a privately issued insurance policy. We hypothesize that the provision of a choice in funds led to risk-sorting among the banks, with the relatively conservative institutions opting for the comparatively rigorous bond security system. Employing a probit model with heteroskedasticity, the evidence we obtain from balance sheet data recorded at the time the banks were required to enlist in an insurance plan indicates that such was the case, as the alternative plan relying on privately issued insurance was widely unpopular except among relatively conservative and well-managed institutions.

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Article provided by Springer in its journal Journal of Financial Services Research.

Volume (Year): 17 (2000)
Issue (Month): 3 (September)
Pages: 237-258

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Handle: RePEc:kap:jfsres:v:17:y:2000:i:3:p:237-258
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  1. Merton, Robert C., 1977. "On the cost of deposit insurance when there are surveillance costs," Working papers 903-77., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  2. Flannery, Mark J, 1998. "Using Market Information in Prudential Bank Supervision: A Review of the U.S. Empirical Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 273-305, August.
  3. Wheelock, David C & Kumbhakar, Subal C, 1995. "Which Banks Choose Deposit Insurance? Evidence of Adverse Selection and Moral Hazard in a Voluntary Insurance System," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(1), pages 186-201, February.
  4. O'Higgins, Niall, 1994. "YTS, Employment, and Sample Selection Bias," Oxford Economic Papers, Oxford University Press, vol. 46(4), pages 605-28, October.
  5. Charles W. Calomiris, 1989. "Deposit insurance: lessons from the record," Economic Perspectives, Federal Reserve Bank of Chicago, issue May, pages 10-30.
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  7. James B. Thomson, 1986. "The use of market information in pricing deposit insurance," Working Paper 8609, Federal Reserve Bank of Cleveland.
  8. Rebel A. Cole & Jeffery W. Gunther, 1993. "Separating the likelihood and timing of bank failure," Financial Industry Studies Working Paper 93-2, Federal Reserve Bank of Dallas.
  9. Yatchew, Adonis & Griliches, Zvi, 1985. "Specification Error in Probit Models," The Review of Economics and Statistics, MIT Press, vol. 67(1), pages 134-39, February.
  10. Gerald P. Dwyer, Jr. & Iftekhar Hasan, 1996. "Suspension of payments, bank failures, and the nonbank public's losses," FRB Atlanta Working Paper No. 96-3, Federal Reserve Bank of Atlanta.
  11. Pennacchi, George G, 1987. "A Reexamination of the Over- (or Under-) Pricing of Deposit Insurance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(3), pages 340-60, August.
  12. Calomiris, Charles W., 1990. "Is Deposit Insurance Necessary? A Historical Perspective," The Journal of Economic History, Cambridge University Press, vol. 50(02), pages 283-295, June.
  13. Edward J. Kane, 1987. "No Room for Weak Links in the Chain of Deposit Insurance Reform," NBER Working Papers 2317, National Bureau of Economic Research, Inc.
  14. Osterberg, William P. & Thomson, James B., 1991. "The effect of subordinated debt and surety bonds on the cost of capital for banks and the value of federal deposit insurance," Journal of Banking & Finance, Elsevier, vol. 15(4-5), pages 939-953, September.
  15. Gorton, Gary, 1996. "Reputation Formation in Early Bank Note Markets," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 346-97, April.
  16. Knapp, Laura Greene & Seaks, Terry G, 1992. "An Analysis of the Probability of Default on Federally Guaranteed Student Loans," The Review of Economics and Statistics, MIT Press, vol. 74(3), pages 404-11, August.
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