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Deposit Insurance, Moral Hazard and the Risk of Runs

  • Nancy Silva
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    The effectiveness of deposit insurance in eliminating panic runs varies with the size of coverage and the degree of supervisory involvement of the agency in charge of insurance. When the agency is not involved in the supervision of banks, partial insurance preserves the monitoring role of depositors and reduces the region for which runs occur, but it is unable of completely eliminating them. When the agency has a high degree of supervisory involvement, even with partial insurance panic runs disappear as the regulator's signal becomes more precise. However, the smaller the protection offered to depositors, the higher is forbearance. Deposit insurance induces moral hazard by increasing the equilibrium value of the demand deposit contract in the interim period, though this effect seems to be smaller under a broad mandate. Therefore, a scheme where the insurance agency has more supervisory involvement should be preferred.

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    Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 474.

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    Date of creation: Jun 2008
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    Handle: RePEc:chb:bcchwp:474
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    1. Carlsson, H. & van Damme, E.E.C., 1990. "Global games and equilibrium selection," Discussion Paper 1990-52, Tilburg University, Center for Economic Research.
    2. Acharya, Viral V & Yorulmazer, Tanju, 2004. "Too Many to Fail - An Analysis of Time Inconsistency in Bank Closure Policies," CEPR Discussion Papers 4778, C.E.P.R. Discussion Papers.
    3. Roberto Chang & Andres Velasco, 1997. "Financial fragility and the exchange rate regime," Working Paper 97-16, Federal Reserve Bank of Atlanta.
    4. Acharya, Sankarshan & Dreyfus, Jean-Francois, 1989. " Optimal Bank Reorganization Policies and the Pricing of Federal Deposit Insurance," Journal of Finance, American Finance Association, vol. 44(5), pages 1313-33, December.
    5. Marc Quintyn & David S. Hoelscher, 2003. "Managing Systemic Banking Crises," IMF Occasional Papers 224, International Monetary Fund.
    6. Xavier Freixas, 1999. "Optimal Bail Out Policy, Conditionality and Creative Ambiguity," FMG Discussion Papers dp327, Financial Markets Group.
    7. Alonso, Irasema, 1996. "On avoiding bank runs," Journal of Monetary Economics, Elsevier, vol. 37(1), pages 73-87, February.
    8. Franklin Allen & Douglas Gale, 1976. "Optimal Financial Crises," Center for Financial Institutions Working Papers 97-01, Wharton School Center for Financial Institutions, University of Pennsylvania.
    9. repec:ner:tilbur:urn:nbn:nl:ui:12-154416 is not listed on IDEAS
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