Deposit Insurance and Reinsurance: A General Equilibrium Perspective

Volker Britz, Hans Gersbach and Hans Haller

No 11947, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We study the consequences and optimal design of bank deposit insurance and reinsurance in a general equilibrium setting. The model involves two production sectors. One sector is financed by issuing bonds to risk–averse households. Firms in the other sector are monitored and financed by banks. Households fund banks through deposits and equity. Deposits are explicitly insured by a deposit insurance fund. Any remaining shortfall is implicitly guaranteed by the government. The deposit insurance fund charges banks a premium per unit of deposits whereas the government finances any necessary bail-outs by lump-sum taxation of households. When the deposit insurance premium is actuarially fair or higher than actuarially fair, two types of equilibria emerge: One type of equilibria supports the Pareto optimal allocation, and the other type does not. In the latter case, bank lending is too large relative to equity and the probability that the banking system collapses is positive. Next, we show that a judicious combination of deposit insurance and reinsurance eliminates all non–optimal equilibrium allocations. Our paper provides a benchmark result for policy proposals that advocate deposit insurance cum reinsurance.

Keywords: Financial intermediation; Deposit insurance; Capital structure; General equilibrium; Reinsurance (search for similar items in EconPapers)
JEL-codes: D53 E44 G2 (search for similar items in EconPapers)
Date: 2017-03
New Economics Papers: this item is included in nep-cba, nep-dge, nep-ias and nep-mac
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