Household Portfolio and Deposit Insurance: Implications for the Supply of Safe Assets

This paper investigates the effect of deposit insurance (DI) on household portfolio allocation between bank deposits and risky assets. Theoretically, limited DI creates a kink in the capital allocation line, causing depositor bunching at the DI threshold and increased equity holdings. Using a natural experiment in India and individual holdings on stocks, deposits, and mutual funds, we confirm depositor bunching at the DI threshold. Leveraging a bunching-in-differences design, we show that DI expansion shifts portfolios from equities and mutual funds to deposits, driven by unmet demand for safe assets. Bunchers increase their deposits between 3.6% and 5.1% by liquidating their stock holdings, which were more exposed to safer state-owned enterprises, transiently affecting the asset prices of these stocks. We show that the share of bunchers is a sufficient statistic to measure the depositor-implied risk of bank default. Our estimates of the welfare effect of changes in DI show that depositors gain at least 4% as DI increases, even after accounting for the resulting moral hazard by banks.