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The optimal level of deposit insurance coverage

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  • Michael Manz

Abstract

This paper develops a global game model that allows for a rigorous analysis of partial deposit insurance and provides the first comparative statics of the optimal level of deposit coverage. The optimal amount of coverage increases with lower bank liquidity requirements, with a higher precision of depositors' information, and with a lower relevance of large, uninsured creditors, and it should not be increased in anticipation of an economic downturn. Optimal insurance is higher if there is contagion and lower if banks can assume excessive risk, but interestingly, a high level of coverage may not be optimal even in the absence of moral hazard on the part of banks. The model supports the inauguration of coinsurance provisions and is applied to compare various policies addressing financial fragility. While an optimal lending of last resort policy can outperform deposit insurance, anticipated bailouts are inferior in terms of welfare. Capital requirements are not a substitute for insurance, but mitigate excessive risk taking.

Suggested Citation

  • Michael Manz, 2009. "The optimal level of deposit insurance coverage," Working Papers 09-6, Federal Reserve Bank of Boston.
  • Handle: RePEc:fip:fedbwp:09-6
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Optimal deposit insurance
      by Economic Logician in Economic Logic on 2009-09-07 20:29:00

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    Cited by:

    1. Shy, Oz & Stenbacka, Rune & Yankov, Vladimir, 2016. "Limited deposit insurance coverage and bank competition," Journal of Banking & Finance, Elsevier, vol. 71(C), pages 95-108.
    2. Li, Gan & Wen-Yao, Wang, 2010. "Partial Deposit Insurance and Moral Hazard in Banking," MPRA Paper 25798, University Library of Munich, Germany.

    More about this item

    Keywords

    Deposit insurance;

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    1. Economic Logic blog

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