Deposit Insurance and Risk Management of the U.S. Banking System: How Much? How Safe? Who Pays?
We examine the question of deposit insurance through the lens of risk management by addressing three key issues: 1) how big should the fund be; 2) how should coverage be priced; and 3) who pays in the event of loss. We propose a risk-based premium system that is explicitly based on the loss distribution faced by the FDIC. The loss distribution can be used to determine the appropriate level of fund adequacy and reserving in terms of a stated confidence interval and to identify risk-based pricing options. We explicitly estimate that distribution using two different approaches and find that reserves are sufficient to cover roughly 99.85% of the loss distribution corresponding to about a BBB+ rating. We then identify three risk-sharing alternatives addressing who is responsible for funding losses in different parts of the loss distribution. We show in an example that expected loss based pricing, while appropriately penalizing riskier banks, also penalizes smaller banks. By contrast, unexpected loss contribution based pricing significantly penalizes very large banks because large exposures contribute disproportionately to overall (FDIC) portfolio risk.
|Date of creation:||Apr 2002|
|Contact details of provider:|| Postal: 3301 Steinberg Hall-Dietrich Hall, 3620 Locust Walk, Philadelphia, PA 19104.6367|
Web page: http://fic.wharton.upenn.edu/fic/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Diana Hancock & Myron Kwast, 2001.
"Using Subordinated Debt to Monitor Bank Holding Companies: Is it Feasible?,"
Journal of Financial Services Research,
Springer;Western Finance Association, vol. 20(2), pages 147-187, October.
- Diana Hancock & Myron L. Kwast, 2001. "Using subordinated debt to monitor bank holding companies: is it feasible?," Finance and Economics Discussion Series 2001-22, Board of Governors of the Federal Reserve System (U.S.).
- Demirguc-Kunt, Asl1 & Huizinga, Harry, 1999.
"Market discipline and financial safety net design,"
Policy Research Working Paper Series
2183, The World Bank.
- Swidler, Steve & Wilcox, James A., 2002. "Information about bank risk in options prices," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 1033-1057, May.
- Jon Frye, 2000. "Depressing recoveries," Emerging Issues, Federal Reserve Bank of Chicago, issue Oct.
- Barth, James R. & Caprio, Gerard Jr. & Levine, Ross, 2004.
"Bank regulation and supervision: what works best?,"
Journal of Financial Intermediation,
Elsevier, vol. 13(2), pages 205-248, April.
- Barth, James R. & Caprio Jr., Gerard & Levine, Ross, 2001. "Bank regulation and supervision : what works best?," Policy Research Working Paper Series 2725, The World Bank.
- James R. Barth & Gerard Caprio, Jr. & Ross Levine, 2002. "Bank Regulation and Supervision: What Works Best?," NBER Working Papers 9323, National Bureau of Economic Research, Inc.
- Donald P. Morgan, 2002. "Rating Banks: Risk and Uncertainty in an Opaque Industry," American Economic Review, American Economic Association, vol. 92(4), pages 874-888, September.
- Berger, Allen N. & Herring, Richard J. & Szego, Giorgio P., 1995.
"The role of capital in financial institutions,"
Journal of Banking & Finance,
Elsevier, vol. 19(3-4), pages 393-430, June.
- Allen N. Berger & Richard J. Herring & Giorgio P. Szegö, 1995. "The Role of Capital in Financial Institutions," Center for Financial Institutions Working Papers 95-01, Wharton School Center for Financial Institutions, University of Pennsylvania.
- Allen N. Berger & Richard J. Herring & Giorgio P. Szego, 1995. "The role of capital in financial institutions," Finance and Economics Discussion Series 95-23, Board of Governors of the Federal Reserve System (U.S.).
- Xavier Freixas, 1999.
"Optimal bail out policy, conditionality and constructive ambiguity,"
Economics Working Papers
400, Department of Economics and Business, Universitat Pompeu Fabra.
- X. Freixas, 2000. "Optimal Bail Out Policy, Conditionality and Constructive Ambiguity," DNB Staff Reports (discontinued) 49, Netherlands Central Bank.
- Ronn, Ehud I & Verma, Avinash K, 1986. " Pricing Risk-Adjusted Deposit Insurance: An Option-Based Model," Journal of Finance, American Finance Association, vol. 41(4), pages 871-895, September.
- Pennacchi, George G, 1987. "A Reexamination of the Over- (or Under-) Pricing of Deposit Insurance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(3), pages 340-360, August.
- Joe Peek & Eric S. Rosengren, 1996. "The use of capital ratios to trigger intervention in problem banks: too little, too late," New England Economic Review, Federal Reserve Bank of Boston, issue Sep, pages 49-58.
- Caprio, Gerard Jr. & Klingebiel, Daniela, 1996. "Bank insolvencies : cross-country experience," Policy Research Working Paper Series 1620, The World Bank.
- Douglas W. Diamond & Philip H. Dybvig, 2000.
"Bank runs, deposit insurance, and liquidity,"
Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
- Merton, Robert C., 1973.
"On the pricing of corporate debt: the risk structure of interest rates,"
684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
- Michael B. Gordy, 1998.
"A comparative anatomy of credit risk models,"
Finance and Economics Discussion Series
1998-47, Board of Governors of the Federal Reserve System (U.S.).
- Mark M. Spiegel, 2001. "The disposition of failed bank assets: put guarantees or loss-sharing arrangements?," Working Paper Series 2001-12, Federal Reserve Bank of San Francisco.
- João A. C. Santos, 2000. "Bank capital regulation in contemporary banking theory: a review of the literature," BIS Working Papers 90, Bank for International Settlements.
- Marcus, Alan J & Shaked, Israel, 1984. "The Valuation of FDIC Deposit Insurance Using Option-pricing Estimates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(4), pages 446-460, November.
- David M. Jones & John J. Mingo, 1998. "Industry practices in credit risk modeling and internal capital allocations: implications for a models-based regulatory capital standard," Economic Policy Review, Federal Reserve Bank of New York, issue Oct, pages 53-60.
- Jones, David S. & King, Kathleen Kuester, 1995. "The implementation of prompt corrective action: An assessment," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 491-510, June.
- Buser, Stephen A & Chen, Andrew H & Kane, Edward J, 1981. "Federal Deposit Insurance, Regulatory Policy, and Optimal Bank Capital," Journal of Finance, American Finance Association, vol. 36(1), pages 51-60, March.
- Calem, Paul & Rob, Rafael, 1999. "The Impact of Capital-Based Regulation on Bank Risk-Taking," Journal of Financial Intermediation, Elsevier, vol. 8(4), pages 317-352, October.
- James, Christopher, 1991. " The Losses Realized in Bank Failures," Journal of Finance, American Finance Association, vol. 46(4), pages 1223-1242, September.
- Calomiris, Charles W., 1999. "Building an incentive-compatible safety net," Journal of Banking & Finance, Elsevier, vol. 23(10), pages 1499-1519, October.
When requesting a correction, please mention this item's handle: RePEc:wop:pennin:02-02. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Thomas Krichel)
If references are entirely missing, you can add them using this form.