Private Deposit Insurance, Deposit Flows, and Bank Lending

Abstract

We examine the role of private deposit insurance as a complement to federal deposit insurance for deposit flows, bank lending, and moral hazard during a financial crisis. We show that banks whose deposits are federally and privately insured obtain more deposits, expand lending, and remain prudent in the mortgage origination process during the subprime crisis, in contrast to banks whose deposits are only federally insured. Deposit inflows are stronger prior to the increase of the federal deposit insurance limit and introduction of the Transaction Account Guarantee Program. Our results highlight a role for private sector solutions in the safety net.