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A Contracting-Theory Interpretation of the Origins of Federal Deposit Insurance

  • Edward J. Kane
  • Berry K. Wilson

Conventional wisdom holds that the enactment of federal deposit insurance helped small rural banks at the expense of large urban institutions. This paper uses asymmetric information, agency-cost paradigms from corporate finance theory and data on bank stock prices to show how deposit insurance could and did help stockholders of large banks. The broadening stockholder distribution of large banks during the stock market bubble of the late 1920s undermined the efficiency of double liability provisions in controlling incentive conflict among large bank stakeholders. Federal deposit insurance restored depositor confidence by asking government officials to take over and bond the task of monitoring managerial performance and solvency at U.S. banks.

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File URL: http://www.nber.org/papers/w6451.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6451.

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Date of creation: Mar 1998
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Publication status: published as Journal of Money, Credit and Banking, Vol. 30 (August 2000): 51-74.
Handle: RePEc:nbr:nberwo:6451
Note: CF
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  1. Benjamin C. Esty, 1997. "The impact of contingent liability on commercial bank risk taking," Proceedings 557, Federal Reserve Bank of Chicago.
  2. Gorton, Gary, 1988. "Banking Panics and Business Cycles," Oxford Economic Papers, Oxford University Press, vol. 40(4), pages 751-81, December.
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  8. Charles W. Calomiris & Eugene N. White, 1994. "The Origins of Federal Deposit Insurance," NBER Chapters, in: The Regulated Economy: A Historical Approach to Political Economy, pages 145-188 National Bureau of Economic Research, Inc.
  9. Peltzman, Sam, 1970. "Capital Investment in Commercial Banking and Its Relationship to Portfolio Regulation," Journal of Political Economy, University of Chicago Press, vol. 78(1), pages 1-26, Jan.-Feb..
  10. Ritter, Jay R, 1991. " The Long-run Performance of Initial Public Offerings," Journal of Finance, American Finance Association, vol. 46(1), pages 3-27, March.
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  13. Kane, Edward J., 1995. "Three paradigms for the role of capitalization requirements in insured financial institutions," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 431-459, June.
  14. Calomiris, Charles W & Kahn, Charles M, 1991. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, American Economic Association, vol. 81(3), pages 497-513, June.
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  16. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  17. McNichols, Maureen & Dravid, Ajay, 1990. " Stock Dividends, Stock Splits, and Signaling," Journal of Finance, American Finance Association, vol. 45(3), pages 857-79, July.
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