Fairly Priced Deposit Insurance, Incentive Compatible Regulations, and Bank Asset Choices

Suk Heun Yoon and Sumon C. Mazumdar
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Suk Heun Yoon: Korea Institute of Finance
Sumon C. Mazumdar: McGill University, Faculty of Management

A chapter in Financial Risk and Derivatives, 1996, pp 123-141 from Springer

Abstract: Abstract This article provides incentive compatible regulations that support fairly priced deposit insurance in a competitive banking industry. If informational asymmetry exists between the regulator and banks regarding loan quality, but the regulator can observe actual loan rates charged, then imposing a capital requirement schedule that leads market loan rates to decrease in loan quality is shown to be incentive compatible. Competition in the loan market induces banks to be indifferent to all loans that satisfy a minimum acceptable quality and reject all riskier loans. The regulator could reduce the banking industry’s riskiness by imposing stricter capital requirements that increase this minimum quality.

Keywords: deposit insurance; incentive compatibility (search for similar items in EconPapers)
Date: 1996
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Persistent link: https://EconPapers.repec.org/RePEc:spr:sprchp:978-94-009-1826-9_7

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DOI: 10.1007/978-94-009-1826-9_7

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