Deposit insurance

Eugene White ()

No 1541, Policy Research Working Paper Series from The World Bank

Abstract: Should deposit insurance be recommended? No. History teaches us three lessons: 1) deposit insurance was not adopted primarily to protect the depositor. There were many ways to increase the soundness of the banking system. The leading alternative was to allow branching and the diversification of institutions by geography and product line. But monetary contraction and the politics of the banking crisis empowered small banks instead; 2) the history of federal and state insurance plans shows that it is all but impossible to escape the moral hazard and other problems inherent in deposit insurance; and 3) in setting up banking regulations, including deposit insurance, a banking lobby will be created that will campaign to protect the industry as it stands, and the industry will be pushed on a course that will be difficult to alter. The public is greatly concerned about the safety of its deposits. The problem is one of information: for households and small businesses, it is costly to monitor the performance of banks and decide which is safest. There is strong historical precedent for at least one alternative to deposit insurance and its perverse effects: regulators could require each bank to offer deposit accounts that are segregated, treasury-bill mutual funds. This type of account is effectively insurance from the government, with the same guarantee as government bonds, but without the wrong incentives for financial institutions that arise from deposit insurance.

Keywords: Banks&Banking Reform; Insurance&Risk Mitigation; Financial Intermediation; Payment Systems&Infrastructure; Financial Crisis Management&Restructuring; Banks&Banking Reform; Financial Intermediation; Financial Crisis Management&Restructuring; Insurance&Risk Mitigation; Insurance Law (search for similar items in EconPapers)
Date: 1995-11-30
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Citations: View citations in EconPapers (18)

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