Is Deposit Insurance a
Good Thing, and If So, Who Should Pay for It?
Alan D. Morrison, Saïd Business School &
Merton College, University of Oxford.
Lucy White, Harvard Business School
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 so 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.
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