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Optimal Deposit Insurance In A Macroeconomic Model With Runs

Author

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  • Vedant Agarwal

    (Centre for Advanced Financial Research and Learning (CAFRAL))

Abstract

This paper examines the effects of deposit insurance in a quantitative macroeconomic model that incorporates the risk of deposit runs faced by banks. During systemic panic episodes, alert uninsured depositors tend to withdraw their funds from banks they perceive as vulnerable. While deposit insurance reduces banks’ susceptibility to such runs, it may also weaken their risk management incentives, resulting in a Ushaped relationship between insurance coverage and the risk of bank failure. The model suggests that the welfare-maximizing level of deposit insurance coverage for the U.S. in 2008 closely aligns with the observed level. A moderate increase in coverage may be optimal in contexts of heightened depositor alertness—driven by technological or demographic factors—, greater fiscal capacity or stronger capital requirements.

Suggested Citation

  • Vedant Agarwal, 2025. "Optimal Deposit Insurance In A Macroeconomic Model With Runs," Working Papers 022258, Centre for Advanced Financial Research and Learning (CAFRAL).
    • Handle: RePEc:ris:cafral:022258
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    Keywords

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    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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