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Deposit Insurance, Moral Hazard and the Risk of Runs

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  • Nancy Silva

Abstract

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.

Suggested Citation

  • Nancy Silva, 2008. "Deposit Insurance, Moral Hazard and the Risk of Runs," Working Papers Central Bank of Chile 474, Central Bank of Chile.
    • Handle: RePEc:chb:bcchwp:474
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    File URL: https://www.bcentral.cl/documents/33528/133326/DTBC_474.pdf
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    1. repec:zbw:bofrdp:urn:nbn:fi:bof-201504131153 is not listed on IDEAS
    2. Romero-Ramírez, Erick & Venegas-Martínez, Francisco & Trejo-García, José Carlos, 2019. "Revisitando los modelos de Birnbaum-Chávez y de Diamond-Dybvig sobre corridas bancarias ¿Las corridas dependen sólo de fundamentos económicos o también de factores psicológicos?," eseconomía, Escuela Superior de Economía, Instituto Politécnico Nacional, vol. 14(50), pages 7-40, Primer se.
    3. repec:zbw:bofrdp:2015_010 is not listed on IDEAS
    4. Kiema, Ilkka & Jokivuolle, Esa, 2015. "Why are bank runs sometimes partial?," Research Discussion Papers 10/2015, Bank of Finland.
    5. repec:bof:bofrdp:urn:nbn:fi:bof-201504131153 is not listed on IDEAS
    6. Kiema, Ilkka & Jokivuolle, Esa, 2015. "Why are bank runs sometimes partial?," Bank of Finland Research Discussion Papers 10/2015, Bank of Finland.

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