Did the Introduction of Fixed-Rate Federal Deposit Insurance Increase Bank Risk?

Abstract

We investigate whether the introduction of fixed-price U.S. federal deposit insurance increased the risk-taking of banks. We examine 70 financial institutions and find that banks in general became more risky after the introduction of deposit insurance. However, a subset of well-performing banks reduced their risk. Deposit insurance brought about stability in that depositors returned to weaker banks. Although investors did not see deposit insurance as a net subsidy to the banking industry, investors believed deposit insurance would allow smaller banks to compete better against bigger banks. While deposit insurance allowed greater risk-taking among some banks, it also brought more stability and competition within the banking industry.