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Deposit insurance and regulation in a Diamond-Dybvig banking model with a risky technology (*)

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  • Denise Hazlett

    (Department of Economics, Whitman College, Walla Walla, WA 99362, USA)

Abstract

Three deposit insurance schemes are studied in a version of the Diamond-Dybvig banking model with a risky technology. The schemes include a full deposit guarantee and two alternatives which people have suggested as ways to limit the moral hazard problem of deposit insurance: deductible and coinsurance. Regulation to suppress the moral hazard problem under each scheme takes the form of solvency and incentive compatibility constraints. When the regulation is relaxed slightly, as it might be under regulatory error, the insurer's payout is lower under the alternatives than under the full guarantee. However, the coinsurance and deductible schemes are less effective at preventing bank runs than the full guarantee. Moreover, in some environments, even the full guarantee itself does not provide enough reassurance to rule out bank runs.

Suggested Citation

  • Denise Hazlett, 1997. "Deposit insurance and regulation in a Diamond-Dybvig banking model with a risky technology (*)," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 9(3), pages 453-470.
  • Handle: RePEc:spr:joecth:v:9:y:1997:i:3:p:453-470 Note: Received: May 8, 1995; revised version August 14, 1995
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    References listed on IDEAS

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    Cited by:

    1. Antoine Martin, 2006. "Liquidity provision vs. deposit insurance: preventing bank panics without moral hazard," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), pages 197-211.
    2. Samartin, Margarita, 2003. "Should bank runs be prevented?," Journal of Banking & Finance, Elsevier, vol. 27(5), pages 977-1000, May.
    3. Harold Ngalawa & Fulbert Tchana Tchana & Nicola Viegi, 2016. "Banking instability and deposit insurance: The role of moral hazard," Journal of Applied Economics, Universidad del CEMA, vol. 19, pages 323-350, November.
    4. Antoine Martin, 2006. "Liquidity provision vs. deposit insurance: preventing bank panics without moral hazard," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), pages 197-211.
    5. van Praag, Bernard M. S., 2015. "A New View on Panel Econometrics: Is Probit Feasible After All?," IZA Discussion Papers 9345, Institute for the Study of Labor (IZA).
    6. Lee, Wai Sing & Kwok, Chuck C. Y., 2000. "Domestic and international practice of deposit insurance: a survey," Journal of Multinational Financial Management, Elsevier, pages 29-62.
    7. Niinimaki, Juha-Pekka, 2002. "Do time deposits prevent bank runs?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 12(1), pages 19-31, February.

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