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Deposit insurance: a reconsideration

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  • John H. Boyd
  • Chun Chang
  • Bruce D. Smith

Abstract

This paper undertakes a simple general equilibrium analysis of the consequences of deposit insurance programs, the way in which they are priced and the way in which they fund revenue shortfalls. We show that the central issue is how the government will make up any FDIC losses. Under one scheme for making up the losses, we show that FDIC policy is irrelevant: it does not matter what premium is charged, nor does it matter how big FDIC losses are. Under another scheme, all that matters is the magnitude of the losses. And there is no presumption that small losses are “good.” We also show that multiple equilibria can be observed and Pareto ranked. Some economies may be “trapped” in equilibria with inefficient financial systems. Our analysis provides counterexamples to the following propositions. (1) Actuarially fair pricing of deposit insurance is always desirable. (2) Implicit FDIC subsidization of banks through deposit insurance is always undesirable. (3) “Large” FDIC losses are necessarily symptomatic of a poorly designed deposit insurance system.

Suggested Citation

  • John H. Boyd & Chun Chang & Bruce D. Smith, 1998. "Deposit insurance: a reconsideration," Working Papers 593, Federal Reserve Bank of Minneapolis.
  • Handle: RePEc:fip:fedmwp:593
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Marshall, David A. & Prescott, Edward Simpson, 2006. "State-contingent bank regulation with unobserved actions and unobserved characteristics," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 2015-2049, November.
    2. Gianni De Nicolo & Marcella Lucchetta, 2009. "Financial Intermediation, Competition, and Risk; A General Equilibrium Exposition," IMF Working Papers 09/105, International Monetary Fund.
    3. Kathleen McDill & Andrea M. Maechler, 2003. "Dynamic Depositor Discipline in U.S. Banks," IMF Working Papers 03/226, International Monetary Fund.
    4. John H. Boyd & Gianni De Nicoló & Bruce D. Smith, 2004. "Crises in competitive versus monopolistic banking systems," Proceedings, Federal Reserve Bank of Cleveland, pages 487-509.
    5. Marshall, David A. & Prescott, Edward Simpson, 2006. "State-contingent bank regulation with unobserved actions and unobserved characteristics," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 2015-2049, November.
    6. Marshall, David A. & Prescott, Edward Simpson, 2001. "Bank capital regulation with and without state-contingent penalties," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 54(1), pages 139-184, June.
    7. Wu, Yuliang & Bowe, Michael, 2012. "Information disclosure and depositor discipline in the Chinese banking sector," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 22(4), pages 855-878.
    8. Todd Keister, 2016. "Bailouts and Financial Fragility," Review of Economic Studies, Oxford University Press, vol. 83(2), pages 704-736.
    9. Elena Loukoianova & Gianni De Nicolo & John H. Boyd, 2009. "Banking Crises and Crisis Dating; Theory and Evidence," IMF Working Papers 09/141, International Monetary Fund.
    10. 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), vol. 28(1), pages 197-211, May.
    11. Samartín Sáenz, Margarita & Cardone Riportella, Clara & Bustamante, Rodrigo, 2004. "Was the Argentine corralito an efficient measure?: a note," DEE - Working Papers. Business Economics. WB wb042209, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    12. Maechler, Andrea M. & McDill, Kathleen M., 2006. "Dynamic depositor discipline in US banks," Journal of Banking & Finance, Elsevier, vol. 30(7), pages 1871-1898, July.
    13. Arping, Stefan, 2010. "The pricing of bank debt guarantees," Economics Letters, Elsevier, vol. 108(2), pages 119-121, August.
    14. Gersbach, Hans & Haller, Hans & Volker, Britz, 2017. "Deposit Insurance and Reinsurance: A General Equilibrium Perspective," CEPR Discussion Papers 11947, C.E.P.R. Discussion Papers.
    15. repec:kap:annfin:v:13:y:2017:i:1:d:10.1007_s10436-016-0288-2 is not listed on IDEAS
    16. Ikuko Fueda & Masaru Konishi, 2007. "Depositors’ Response to Deposit Insurance Reforms: Evidence from Japan, 1990–2005," Journal of Financial Services Research, Springer;Western Finance Association, vol. 31(2), pages 101-122, June.
    17. Edward Simpson Prescott, 2002. "Can risk-based deposit insurance premiums control moral hazard?," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 87-100.
    18. Gianni De Nicolo, 2000. "Size, charter value and risk in banking: an international perspective," International Finance Discussion Papers 689, Board of Governors of the Federal Reserve System (U.S.).
    19. Gianni De Nicolo & John H. Boyd, 2003. "Bank Risk-Taking and Competition Revisited," IMF Working Papers 03/114, International Monetary Fund.
    20. Li, Gan & Wen-Yao, Wang, 2010. "Partial Deposit Insurance and Moral Hazard in Banking," MPRA Paper 25798, University Library of Munich, Germany.

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    Keywords

    Deposit insurance;

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