Deposit Insurance, Systemic Risk and Banking Concentration 1

2006

Discussions about the role of deposit insurance within financial stability architecture neglected an impact that the choice of deposit insurance fund's (DIF's) financial instruments may have on banks' incentives to take risks. This paper argues that DIF should borrow against a portion of its exposure which can be expected to recover in distress under reasonable assumptions. DIF should accumulate own funds (equity) only in proportion to expected loss in distress. Creating credit exposure of sound banks and/or other creditors towards deposit insurance institution will increase monitoring incentives. Also it may lead to creditors' demands to participate in a decision making process in a mixed deposit insurance system. This will help to align public and private incentives and increase likelihood of optimum pricing of deposit insurance. Application of this principle of financial management requires continuous risk assessment and stress testing on a bank by bank basis. Short time series and analytical difficulties should not discourage deposit insurers in SEE in applying these methods. Methods can be adjusted in order to be useful at a given level of development of their statistical and analytical systems. Therefore this paper is a plea for an early adoption of financial planning and modeling techniques in deposit insurance in SEE. Application of these techniques is a prerequisite for incentive compatible use of debt in deposit insurance funding.

Journal of Risk and Financial Management

This paper investigates how deposit insurance and capital adequacy affect bank risk for five developed and nine emerging markets over the period of 1992–2015. Although full coverage of deposit insurance induces moral hazard by banks, deposit insurance is still an effective tool, especially during the time of crisis. On the contrary, capital adequacy by itself does not effectively perform the monitoring role and leads to the asset substitution problem. Implementing the safety nets of both deposit insurance and capital adequacy together could be a sustainable financial architecture. Immediate-effect analysis reveals that the interplay between deposit insurance and capital adequacy is indispensable for banking system stability.

SSRN Electronic Journal

focuses on high quality research in economics and business, with special attention to a multidisciplinary approach. In the working papers series the U.S.E. Research Institute publishes preliminary results of ongoing research for early dissemination, to enhance discussion with the academic community and with society at large.

2019

Deposit insurance system was primarely created to protect depositors and their deposits. It creates depositors̕ confidence in the banking system, thus preventing depositor panic and bank run of bank deposits especially in the time of crisis. Since most depositors do not possess adequate knowledge and professional experience, which is necessary to assess bank risks, the operation of deposit insurance system is justified in order to create trust in the banking system. It is believed that the depositor's trust in the banking system and the deposit insurance system ultimately contribute to the maintenance of banking stability. Despite the these significant positive effects of deposit insurance system there are also some negative aspects that have to be taken into account effects on bank stability. They refer to risky bank operations, reduced market discipline, moral hazard, negative selection and the principal-agent problem. Financial crisis in Europe started in 2008, points on the ...

International Journal of Financial Studies, 2021

During the global financial crisis (GFC), regulators and policymakers turned to deposit insurers, along with monetary and fiscal measures, to help restore market confidence and promote financial stability. These events have focused attention on the role of deposit insurers and their role in the banking system. Recent literature reveals that during the GFC, deposit insurance maintained banking stability and successfully prevented customers doing ‘runs’ on the banks. The objective of this paper is to examine the deposit insurance system’s coverage limits and the impact on banking stability, in the context of a jurisdiction’s economic and institutional environment. Our model examines 61 jurisdictions in Asia and Europe with explicit deposit insurance systems, covering the pre- and post-GFC period between 2004 and 2014. We also examine subsets to investigate the effects of the region by comparing Asia and Europe, as well as a subset using the date of establishment of the deposit insuran...

SSRN Electronic Journal, 2000

When there are widespread bank failures, deposit insurance agencies such as the Federal Deposit Insurance Corporation (FDIC) …nd it di¢ cult to sell failed banks at attractive prices. Thus, the deposit insurance fund su¤ers higher drawdowns per dollar of insured deposit when there is a systemic crisis. In turn, the actuarially-fair deposit insurance premium that is charged ex ante to banks increases in joint failure risk in addition to individual failure risk. Further, since bank closure policies re ‡ect greater forbearance in a systemic crisis, banks have incentives to herd. The incentive-e¢ cient premium that accounts for such moral hazard requires a higher charge for joint failure risk than the actuarially-fair one. Similarly, as large bank failures are more likely to be associated with asset …re sales (and regulatory forbearance), the e¢ cient premium for large banks is higher per dollar of insured deposits compared to that for small banks.

International Monetary Fund eBooks, 2006

Journal of Multinational Financial Management, 2000

The literature on deposit insurance tends to be mostly confined to a discussion of the reform proposals and risk-related premium assessment methodologies. The theoretical explanation of the alternatives to the major components of a deposit insurance scheme is sketchy. Comparisons on the international practice of deposit insurance are not extensive and comprehensive enough. To fill the gaps in the literature, this paper examines the theoretical foundations of the key issues of a deposit insurance scheme, provides a critical comparison on the international practice of deposit insurance, and makes suggestions on how a complete deposit insurance scheme can be properly designed and implemented.

SSRN Electronic Journal, 2000

Explicit deposit insurance is a two-edged sword with respect to risktaking. High explicit coverage creates incentives to shift risk to a deposit insurance fund or taxpayers; low explicit coverage may be associated with strong implicit insurance reflecting lack of credibility of noninsurance. Institutions that allow banks to fail without serious contagion effects enhance this credibility. Alternative measures of banks' risktaking are used to test the hypothesis expressed as a U-shaped relationship between explicit coverage and risktaking. The hypothesis is strongly supported when the occurrence of banking crises and non-performing loans are proxies for risktaking in a country's banking system. Institutional characteristics affect the relation between explicit coverage and risk-taking. JEL Classification: G21; G28; F43

Journal of Monetary Economics, 2002

for very helpful comments. We are greatly indebted to Anqing Shi and Tolga Sobac2 for excellent research assistance.

Risks, 2018

Scientific discussions have emphasized that the main problem with the current deposit insurance system is that the current system does not evaluate the risks that banks assume to calculate the deposit insurance premiums in many countries of the European Union (E.U.). Thus, the prevailing system does not safeguard a sufficient level of stability in the banking system. Scientific studies show that the deposit insurance system should consider not only the risk indicators for individual banks, but it must also consider the systemic risk of banks that affects the stability of the banking system. Hence, the question arises as to whether measurements of systemic risk in a common E.U. risk-based deposit insurance system are a formal necessity or if they are a value-adding process. Expanding the discussion of scientists, this article analyzes how contributions to insurance funds would change the banks of Lithuania following the introduction of the E.U.’s overall risk-based deposit insurance ...

Carnegie-Rochester Conference Series on Public Policy, 1993

The current system of deposit insurance has a basic structural problem because *We thank the Carnegie-Rochester Conference participants, and especially 1 For a general overview of deposit-insurance reform, see Barth and Brumbaugh (1992), Barth, Brumbaugh, and Litan (1992), and Brumbaugh (1993). The specific analytical framework of our paper is developed in Merton (199213) Merton and Bodie (1992a,b and c). In the banking literature, the analytical approaches of Black (1985), Black, Miller, and Posner (1978), Gorton and Pennacchi (1992a), and Pierce (1991) are most closely aligned with the development here. 2We have discussed elsewhere deposit insurance as it relates to thrifts. See Merton and Bodie (1992b,c, Section 6). More generally, see J. Barth (1991) and Brumbaugh (1988). 3The thrust of policymaker thinking is often reflected in the titles given to government reports. Thus, the U.S. Treasury entitled its February 1991 detailed proposals for financial system reform, Modernizing the Financial System: Recommendations for Safer, More Competitive Banks. *As here, Diamond and Dybvig (1986) f ecus on the functions of banks. They, however, identify three core functions: (i) asset services, which is making loans; (ii) liability services, which is transaction clearing, providing currency and other means of payment (checks, cash cards); (iii) transformation services, which creates liquidity by buying illiquid loans and issuing liquid deposits. The role of banks in liquidity creation is discussed in Section 3. 5According to the Federal Reserve, at the end of 1990 the breakdown of the loan portfolio of U.S. commercial banks was: commercial and industrial loans 30%, real-estate loans 37%, consumer loans 19%, all other 14%. 'jFor discussion of the role of banks in the intermediation of asymmetric information, see Diamond (1984), Fama (1985), and James (1987). 7We use the term "opaque" here in the sense developed in depth by Ross (1989). "The trend in the recent past is for banks to invest in marketable debt instruments including securitized loans of other banks. To the extent they do so, they are becoming less like the institution we define as commercial banks. The bank assets that lend themselves to being securitized are the ones that are least opaque, such as credit-card and automobile loans. Corporate, commercial real-estate, and sovereign loans are not generally acceptable for securitization and, therefore, tend to stay on the balance sheet of the firm. For an extensive discussion of asset securitization, see the Fall 1988 issue of Journal of Applied Corporate Finance.

Risk Management & Analysis in Financial Institutions eJournal, 2015

The article presents the development of deposit insurance systems in the world and different operational models. A particular attention is paid to different periods of establishment of these institutions as well as the kind of their authority and scope of activity, including the recent changes introduced after the global financial crisis.

SSRN Electronic Journal, 2021

Using evidence from Russia, we explore the effect of the introduction of deposit insurance on bank risk. Drawing on variation in the ratio of firm deposits to total household and firm deposits before the announcement of deposit insurance, so as to capture the magnitude of the decrease in market discipline after the introduction of deposit insurance, we demonstrate that larger declines in market discipline generate larger increases in traditional measures of risk. These results hold in a difference-indifference setting in which private domestic banks serve as the treatment group and state and foreign-owned banks, whose deposit insurance regime does not change, serve as a control group.

2003

This paper extends the Dowd (2000) model by introducing a risky investment technology. This assumption allows to introduce the possibility of an insolvency crisis. A banker may earn a positive expected pro®t by insuring depositors against the technological risk. If the bank has adequate capital, the insurance is credible and an insolvency crisis cannot occur. A public safety net may be unnecessary to prevent insolvency crises.