Deposit Insurance and Subsidized Recapitalizations

Morrison, Alan and White, Lucy (2011) Deposit Insurance and Subsidized Recapitalizations. Journal of Banking and Finance, 35 (12). pp. 3400-3416.

Abstract

The 2007–2009 financial crisis saw a vast expansion in deposit insurance guarantees around the world and yet our understanding of the design and consequences of deposit insurance schemes is in its infancy. We provide a new rationale for the provision of deposit insurance. In our model the banking sector exhibits both adverse selection and moral hazard, which implies that the social benefits of bank monitoring must for incentive reasons be shared between depositors and banks. Consequently, socially too few deposits are made in equilibrium. Deposit insurance – or, equivalently, bank recapitalization – corrects this market failure. We find that deposit insurance should be funded not by banks or depositors but out of general taxation. The optimal level of deposit insurance varies inversely with the quality of the banking system. Hence, when the soundness of the financial sector is uncertain, governments should consider supporting deposit insurance schemes and undertaking subsidized recapitalizations.

Item Type: Article
Keywords: deposit insurance; bank regulation; adverse selection; moral hazard; finance
Subject(s): Corporate reputation
Finance
Centre: Oxford University Centre for Corporate Reputation
Date Deposited: 20 Feb 2012 17:36
Last Modified: 26 Sep 2018 10:39
Funders: N/A
URI: http://eureka.sbs.ox.ac.uk/id/eprint/1692

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