Is Deposit Insurance A Good Thing, And If So, Who Should Pay for It?

Alan Morrison () and Lucy White

No 4424, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Deposit insurance schemes are becoming increasingly popular around the world and yet there is little understanding of how they should be designed and what their consequences are. In this Paper we provide a new rationale for the provision of deposit insurance. We analyse a model in which agents choose between depositing their funds with banks and placing them in a less productive self-managed project. Bankers have valuable but costly project management skills and the banking sector exhibits both adverse selection and moral hazard. Depositors do not fully account for the social benefits accruing from bank management of projects and therefore too few deposits are made in equilibrium. The regulator can correct this market failure by providing deposit insurance to encourage deposits. Contrary to received opinion, we find that deposit insurance should be funded not by bankers or depositors but through general taxation.

Keywords: Deposit insurance; Adverse selection; Moral hazard; Banking systems (search for similar items in EconPapers)
JEL-codes: D82 E42 E58 G21 G22 (search for similar items in EconPapers)
Date: 2004-06
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Citations: View citations in EconPapers (13)

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Working Paper: Is Deposit Insurance a Good Thing, and If So, Who Should Pay for It? (2004)
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