Partial Deposit Insurance and Moral Hazard in Banking

Li, Gan and Wen-Yao, Wang (2010): Partial Deposit Insurance and Moral Hazard in Banking.

Abstract

Abstract: Countries with deposit insurances differ significantly on how much protection their insurance provides. We study the optimal coverage limit in a model of deposit insurance with capital requirements and risk sensitive premia to prevent moral hazard. Depositors have incentives to monitor the bank’s risk taking behavior, thus threatening banks with withdrawals of deposits if necessary. We find that either banking regulations or market discipline is insufficient to reduce bank’s risk. In addition, our numerical example explains the differences in coverage cross countries which agrees with empirical evidence. We show that low income countries provide more generous insurance protection than higher income countries.

• Item Type: MPRA Paper
• Language: English
• Keywords: Depositor’s monitoring; moral hazard; optimal coverage, partial deposit insurance.
• Subjects: E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E65 - Studies of Particular Policy Episodes; G - Financial Economics > G2 - Financial Institutions and Services > G28 - Government Policy and Regulation; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages

References

Acharya, V., J. Santos, and T. Youlmazer, “Systemic Risk and Deposit Insurance Premium,” Economic Policy Review, Forthcoming.

Acharya, V., T. Youlmazer, “Too Many to Fail—An Analysis of Time-inconsistency in bank closure policies,” Journal of Financial intermediation, 16:1 (2007): 1-31.

Barajas, A. and R. Steiner, “Depositor Behavior and Market Discipline in Colombia,” IMF Working Paper #00/214 (2000).

Bhattacharya, S., A. Boot and A.V. Thakor, “The Economics of Bank Regulation,” Journal of Money, Credit, and Banking, 30.4 (1998): 745-770.

Bliss, R. R. and M. J. Flannery, “Market Discipline in the Governance of U.S. Bank Holding Companies: Monitoring vs. Influencing,” Research Department Working Paper Series, # 2000-03 (2000).

Boyd, J.H., C. Chang, and B. D. Smith, “Deposit insurance: a reconsideration,” Journal of Monetary Economics, 49 (2002): 1235–1260.

Chan, Y.S., S.I. Greenbaum, and A.V. Thakor, “Is Fairly Priced Deposit Insurance Possible?,” The Journal of Finance, 47.1 (1992): 227-245.

Chan, Y.S. and K. T. Mark, “Deposits’ Welfare, Deposit Insurance, and Deregulation,” The Journal of Finance, 40.3 (1985), paper and proceedings of the Forty-Third Annual Meeting American Finance Association, Dallas, Texas.

Cooper, R and T. W. Ross, “Bank Runs: Deposit Insurance and Capital Requirements,” International Economic Review, 43.1 (2002): 55-72.

Demirguc-Kunt, A. and E. Detragiache, “Does Deposit Insurance Increase Banking System Stability? An Empirical Investigation,” Journal of Monetary Economics, 49.7 (2002): 1373-1406.

Demirguc-Kunt, A. and E. J. Kane, “Deposit Insurance around the Globe: Where Does It Work?” The Journal of Economic Perspectives, 16.2 (2002): 175-195.

Demirguc-Kunt, A., E. J. Kane and L. Laeven (Eds), “Deposit Insurance around the World: Issues of Design and Implementation,” Cambridge: Publishers MIT Press. (2008).

Demirguc-Kunt, A. and H. Huizinga, “Market Discipline and Deposit Insurance?” Journal of Monetary Economics, 51.2 (2004): 375-399.

Diamond, D.W. and P.H. Dybvig, “Bank Runs, Deposit Insurance, and Liquidity,” The Journal of Political Economy, 91.3 (1983): 401-419.

Ennis, H. and T. Keister, “Bank Runs and Institutions: The Perils of Intervention,” American Economic Review, 99:4 (2009): 1588-1607.

Ennis, H. and T. Keister, “Banking Panics and Policy Responses,” Journal of Monetary Economics, 57:4 (2010): 404-419.

Garcia, G., “Deposit Insurance: A Survey of Actual and Best Practices,” IMF Working Paper # 99/54 (1999).

Giammarino, R., T. Lewis, and D. Sappington, “An Incentive Approach to Banking Regulation,” The Journal of Finance, 48.4 (1993):1523-1542.

Greenspan, A., “Testimony of Chairman Alan Greenspan,” The Federal Reserve Board. April 23, 2002.

http://www.federalreserve.gov/boarddocs /testimony /2002/20020423/default.htm Gropp, R. and J. Vesala, “Deposit Insurance, Moral Hazard and Market Monitoring,” Review of Finance, 8.4 (2004): 571-602.

Hellmann, T.F., K.C. Murdock and J.E. Stiglitz, “Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?,” The American Economic Review, 90.1 (2000): 147-165.

Maechler, A.M. and K.M. McDill, “Dynamic depositor discipline in US banks,” Journal of Banking & Finance, 30. 7 (2006): 1871–1898.

Manz, M., “The Optimal Level of Deposit Insurance Coverage,” FRBB Working Paper #09-6 (2009).