Deposit Insurance Program Research Articles

Kansas’ Experiment with Private Deposit Insurance

Between 1909 and 1922 a private deposit insurance company coexisted with the state-sponsored deposit insurance program in Kansas. This paper documents its development using primary sources. In addition, it examines if affiliation with the private deposit insurance (i) had an effect on risk-taking and the probability of failure; (ii) increased confidence among depositors, and (iii) was influenced by a neighboring bank’s membership in the state’s deposit insurance. We find that affiliation with the private deposit insurance did not affect a bank’s likelihood of failure, although smaller national bank members did increase risk-taking. The evidence does not support the hypothesis that the company enhanced depositor confidence. Lastly, we do find strong evidence that a bank’s decision to join the private deposit insurance was influenced by neighboring banks’ affiliation with the Kansas deposit insurance program.

Moral hazard, external governance and risk-taking: Evidence from commercial banks in China

Using a sample of Chinese commercial banks from 2004 to 2017, this paper investigates whether and how external governance mitigates the moral hazard problem in these banks. China launched its first explicit deposit insurance program in 2015. Taking this program as an example, our empirical results show that the implementation of such a program indeed increases risk-taking of these commercial banks and provide evidence of the presence of moral hazard. We further document that improved external governance via a marketization process plays a role in reducing excessive risk-taking and mitigating the moral hazard problem in the Chinese banking sector.

Private Sector's Over-Indebtedness as a Cause of Inefficiency of Monetary Policy

The paper investigates the reasons why easy monetary policy in the US, Euro area and Japan doesn’t promote economic growth. The paper argues that (i) ineffectiveness of easing monetary policy is caused by cash hoarding caused by excess of deposits over loans and (ii) cash hoarding is caused by over-indebtedness of private sector. It is argued that to increase the efficiency of monetary policy reduction in private sector’s debt burden is necessary that can be achieved through the growth of non-debt financing. For that, it is proposed to increase the attractiveness of trust funds, in particular, to extend the deposit insurance program to funds transferred to trust.

Cash Hoarding as a Crisis of Debt Financing Model

The paper investigates the problem of the excess of deposits in banks over loans observed in the US, Europe and Japan, resulting in the cash hoarding in banks. The paper argues that as the higher the borrowers’ debt service ratio, the greater default risks, borrowers with high debt service ratio tend to reduce loans and increase saving that leads to cash hoarding in banking sector. It is argued that to decrease cash hoarding reduction in the debt burden of economy is necessary that can be achieved through the growth of non-debt financing. For that, it is proposed to increase the attractiveness of trust funds, in particular, to extend the deposit insurance program to funds transferred to trust.

Conning the IADC Newsletters

International Association of Defense Counsel Committee members prepare newsletters on a monthly basis that contain a wide range of practical and helpful material. This section of the Defense Counsel Journal is dedicated to highlighting interesting topics covered in recent newsletters so that other readers can benefit from committee specific articles. SIMILARITIES BETWEEN THE SAVINGS & LOAN CRISIS AND TODAY'S CURRENT FINANCIAL CRISIS: WHAT THE PAST CAN TELL US ABOUT THE FUTURE This article originally appeared in the September 2009 Fidelity and Surety Committee Newsletter. I. Introduction It goes without saying that the financial industry, along with numerous other sectors of the United States and global economies, are currently in peril. According to statistics posted on the Federal Deposit Insurance Corporation's (FDIC's) website, in 2008, twenty-five financial institutions failed in the United States; and as of July 7, 2009, 52 financial institutions already have failed in 2009. (1) By comparison, in 2007, only three banks failed, and in 2005 and 2006, no banks failed. (2) Along with this significant increase in bank failures, it is no surprise that financial institutions have been the main focus of litigation by both private parties and the government. Despite what some could refer to as sensationalism in the media regarding the unprecedented nature of the current crisis, this country weathered a similar collapse of its financial sector during the Savings & Loan (SL (2) the Federal Savings and Loan Insurance Corporation (FSLIC), which insured deposits in SL and (3) the Federal Deposit Insurance Corporation (FDIC), which regulated federally-chartered commercial banks and provided a federal deposit insurance program. …

Deposit Insurance Incentives for Banks in Pre-Depression Texas

This paper uses historical data on Texas banks to examine one possible reform to government-provided deposit insurance, increased reliance on market incentives. The Texas experience is unusual because banks faced two options under which they could join a state-mandated deposit insurance program, one with a market incentive and one without. We find some evidence that banks with insurance which incorporated market incentives had lower risk profiles than banks with insurance which did not incorporate such incentives. For policymakers, the results support for the view that the structure of the deposit insurance program can have an economically significant effect on the moral hazard problem.

APPLYING A TWO-STEP MAXIMUM LIKELIHOOD METHOD TO EXAMINE THE DEPOSIT INSURANCE PROGRAM OF TAIWAN

This paper examines the deposit insurance program of Taiwan. We adopt Duan et al. [4]'s deposit insurance pricing model, and estimate the deposit insurance premium by the Duan and Simonato two-step maximum likelihood method [5]. Our results show that the maximum likelihood estimates for the deposit insurance premium are considerably higher than the official rates currently charged by the Central Deposit Insurance Corporation (CDIC), the deposit insuring agency of Taiwan, indicating that the CDIC deposit insurance program appears to hand out a substantial subsidy to the banks in Taiwan. Our results also show that the CDIC in fact grants too much capital forbearance to the banks, and that the semiannual bank audits currently mandated by the CDIC are in fact much less frequent than our estimated values. These findings may also explain why the estimated rates for the deposit insurance premium are much higher than the current CDIC rates.

Sources Of Non-Performing Loans In Turkish Banking System

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-family: Times New Roman; font-size: x-small;">The purpose of this paper is to examine the impact of the unlimited deposit insurance on non-performing loans and market discipline. Deposit insurance program play a crucial role in achieving financial stability. Governments in many advanced and developing economies established deposit insurance schemes for reducing the risk of systemic failure of banks. Deposit insurance has a beneficial effect of reducing the probability of a bank run.<span style="mso-spacerun: yes;">  </span>However deposit insurance systems have its own set of problems. Deposit insurance systems create moral hazard incentives that encourage banks to take excessive risk. Turkey established an explicit deposit insurance system in 1960. Until 1994, the coverage determined by a flat rate but in that date, Turkey experienced a major economic crisis. In April 1994, Turkish government started to apply an unlimited deposit insurance scheme to restore banking system stability. Unlimited deposit insurance caused a remarkable increase at non-performing loans. This paper empirically estimates the impact of unlimited deposit insurance system on non-performing bank loans (NPLs) and analyses the other potential sources of NPLs. </span></p>

Azerbaijan: deposit insurance system

Purpose – The purpose of this paper is to investigate a deposit insurance program for household deposits, which is designed to act as safety net in order to minimize or eliminate the risk of loss of depositors' funds with banks represents a primary element of this reform.

Deposit Insurance, Banking Reform, and Financial Sector Development in Several Nations of Southeastern Europe

Deposit insurance has spread to many sections of the world. In the newly formed nations of the former Yugoslavia, this has occurred under conditions of post-conflict reconstruction, hyperinflation, and several different governmental structures. Three cases are examined; Bosnia and Herzegovina, Croatia, and Serbia and Montenegro. They all have developed deposit insurance programs. The implementation process was compared to “best practice” recommendations. It is found that the situation in Bosnia and Herzegovina was difficult due to the fractured nature of the Dayton Accord government structure on the one hand but easier to the strong international presence supporting required actions. In the case of Croatia, a unified state emerged from the war, but it was somewhat isolated. Its bank restructuring was costly, and a fragmented deposit insurance program was introduced in the middle of a banking crisis. In the case of Serbia and Montenegro, the bank restructuring process is still underway, and implementation of a functioning deposit insurance program properly awaits its completion.

Deposit Insurance and Financial Development

Do deposit insurance programs contribute to financial development? Yes, but only if the regulatory environment is sound. Cull, Senbet, and Sorge examine the effect of different design features of deposit insurance on long-run financial development, defined to include the level of financial activity, the stability of the banking sector, and the quality of resource allocation. Their empirical analysis is guided by recent theories of banking regulation that employ an agency framework. The authors examine the effect of deposit insurance on the size and volatility of the financial sector in a sample of 58 countries. They find that generous deposit insurance leads to financial instability in lax regulatory environments. But in sound regulatory environments, deposit insurance does have the desired impact on financial development and growth. Thus countries introducing a deposit insurance scheme need to ensure that it is accompanied by a sound regulatory framework. Otherwise, the scheme will likely lead to instability and deter financial development. In weak regulatory environments, policymakers should at least limit deposit insurance coverage. This paper - a product of Finance, Development Research Group - is part of a larger effort in the group to design financial safety nets for developing countries. The study was funded by the Bank's Research Support Budget under the research project Deposit Insurance (RPO 682-90). Robert Cull may be contacted at rcull@worldbank.org.

Deposit insurance: a reconsideration

This paper undertakes a simple general equilibrium analysis of the consequences of deposit insurance programs, the way in which they are priced, and the way in which they fund revenue shortfalls. In our economy, the central issue in analyzing deposit insurance is how the government will make up any FDIC losses. Deposit insurance premia matter only in so far as they affect the level of implied FDIC revenue shortfalls. Moreover, local variations in the magnitude of FDIC losses will generically be irrelevant for the determination of any equilibrium quantities that affect agent welfare. However, large enough changes in these losses can “matter”. There is no presumption that keeping these shortfalls low is a “good idea”. Finally, we show that multiple Pareto-ranked equilibria can be observed. The potential for multiplicity of equilibria may depend on components of FDIC policy. Our analysis provides counterexamples to the following propositions. (1) Actuarially fair pricing of deposit insurance is always desirable. (2) Implicit FDIC subsidization of banks through deposit insurance is always undesirable. (3) “Large” FDIC losses are necessarily symptomatic of a poorly designed deposit insurance system. (4) Risk-based deposit insurance premia can easily be used to reduce moral hazard problems associated with deposit insurance provision.

Adverse Selection and Competing Deposit Insurance Systems in Pre-Depression Texas

In 1910, Texas instituted a unique deposit insurance program for its state chartered banks by providing a choice between two separate plans: the depositors guaranty fund, similar to insurance schemes in several other states, and the depositors bond security system, which required the procurement of a privately issued guarantee of indemnity. While, under most deposit insurance schemes, the incentive to monitor the financial condition of individual banks simply devolves from depositors to regulators, the bond security system established in Texas distinguished itself by attempting to reintroduce market discipline through the indemnity requirement. Using a probit model with heteroscedasticity, we find evidence that the choice of insurance coverage led to risk-sorting among the banks, with relatively conservative and financially secure institutions opting for the comparatively rigorous bond security system. In addition, the bank failure record indicates the risk differentials between banks in the two plans persisted over time and even possibly grew, suggesting the bond security system at least partially avoided the moral hazard incentives associated with the fixed-rate depositors guaranty plan. These findings support the general view that market discipline is effective in banking.

Designing an Efficient and Incentive Compatible Government-Provided Deposit Insurance Program for Developing and Transitional Economies

This paper reviews the causes of recent banking crises, particularly in the United States. The paper argues that to the extent banks are perceived to be special, it is primarily because of poorly designed special public policies, particularly safety nets, rather than their inherent characteristics. These flaws have contributed to the costly recent banking crises in most countries of the world. As a result, preventing future crises centers on correcting the flaws in these policies. The U.S. reformed its government-provided deposit insurance structure in the Federal Deposit Insurance and Corporation Improvement Act (FDICIA) of 1991 to reduce the moral hazard problem of banks and the agency problem of regulators. The reform focuses on imposing regulatory discipline that mimics the discipline the market imposes on firms not subject to a safety net and on resolving a troubled bank before its economic capital is negative. If successful, this would impose losses only on shareholders and make deposit insurance effectively redundant. Aspects of this new structure appear to be appropriate for other countries.

Is deposit insurance inevitable? Lessons from Argentina

This paper explores the decision by the Argentine government to abolish deposit insurance, and its subsequent decision to re-establish a form of deposit insurance. Before 1991, the Argentine banking system operated under a regime of optional, explicit deposit insurance, coupled with extensive implicit deposit insurance in the form of central bank assistance to failing banks. In 1991 and 1992, Argentina reversed this policy by repealing the country's deposit insurance program and attempting to convince financial markets that it would not under any circumstances rescue a failing bank. In 1995, in the face of a forthcoming election and a severe economic crisis sparked by the Mexicon peso devaluation of December 1994, the Argentine government reinstituted a form of deposit insurance in an effort to stave off an all out bank panic. The decision to re-establish deposit insurance appears inconsistent with repeated assurances from high-level officials that the Argentine government would not under any circumstances bail out depositors in a failing bank. These events are of interest to U.S. deposit insurance reform because they allow the investigation of a real-world case in which a significant economic system repealed its program of deposit insurance. It is often said in the United States that cutbacks in the deposit insurance guarantee are politically impossible. Yet such reforms were implemented in Argentina. How those reforms came to pass is a question of some interest for the analysis of U.S. deposit insurance reform. At the same time, the government's subsequent retreat from its commitment to allow troubled banks to fail, without protecting depositors, counsels caution about the efficacy of attempts to eliminate deposit insurance. Argentina's deposit insurance reform could not withstand the political and economic pressures attending a severe crisis that threatened the viability of the overall package of economic change. To what extent can any country reliably commit not to protect bank depositors, given the possibility of a banking crisis and the extraordinary political pressures that attend it? While fundamental reform of deposit insurance does appear possible, the experience in Argentina suggests caution about the durability of such reforms, especially in economic systems characterized by historical instability in banking markets.

The Reform of Federal Deposit Insurance

In the first essay, Calomiris argues that the most desirable means by which to achieve banking system stability is to permit unlimited branch banking combined with the type of privately administered formal deposit insurance programs of antebellum Indiana, Ohio, and Iowa. In the second essay, Barth and Bartholomew argue convincingly that the major culprit in the S&L crisis is the existing structure of the federal deposit insurance system. They take the view that the Financial Institutions Reform, Recovery and Enforcement Act was seriously flawed for its failure to adequately restructure the federal deposit insurance system. Brumbaugh and Litan express the view that due to the widespread use of accounting onventions to conceal balance sheet weaknesses, the number and assets of market-value insolvent banks cannot be known with any certainty. Kane argues that government deposit insurers have hidden or unacknowledged objectives and that these objectives conflict with the presumed long term goals of protecting depositors of modest means and preventing runs in a cost-effective manner. Romer and Weingast demonstrate how politicians benefited by keeping taxpayers uniformed about the thrift crisis and by establishing and enforcing a policy of forbearance. Chirinko and Guill quantitatively examine how macroeconomic shocks affect depository institutions. They argue that major problems can be encountered unless approaches to deposit-insurance reform and regulatory reform explicitly and carefully consider the impacts of such macroeconomic shocks on these institutions. Kaufman observes that, since 1974, the Federal Reserve has provided lender of last resort (LLR) assistance to prolong the life insolvent banks deemed too large to fail (TLTF). He argues that the LLR assistance in recent years has not saved most banks but has provided uninsured depositors time to flee without losses. It has frequently been argues that accounting techniques have played a significant part in the interaction of depository institutions and federal deposit insurance regulation. The last two papers in this book focus on the attributes of market-value accounting.

The budgetary arithmetics of loan guarantees and deposit insurance : A comment

The main focus of Philippe Weil’s paper is on the new U.S. budgetary treatment of direct loans and loan guarantees that began with the Credit Reform Act (CRA) of 1990. W ‘1’ er s analysis raises fundamental questions about this new treatment. Research work like this is useful-whether or not one agrees with the recommendations-because of the importance of U.S. federal budget policy for economic performance in the United States and other countries. The major change in budgetary treatment that Weil addresses is the charging of the subsidy cost, and only the subsidy cost, of loan guarantees and direct loans to the budget. Before the Credit Reform Act of 1990 the full amount of direct loans and none of the loan guarantees was charged to the budget when the loan program was enacted. Two exceptions to this new treatment need to be stressed. First, old loans and old loan guarantees continue to be subject to the pre-1990 budget law. Effectively, “two regimes” are set up. One regime is for old loans and one for new ones. This “grandfathering” provision leads to an inconsistency of treatment, but the inconsistency will diminish over time as new loans grow relative to old loans. The second exception is that some items are not subject to the new treatment. For example, deposit insurance programs and the activities of government-sponsored agencies (Fannie Mae, Freddie Mac, etc.) are excluded. The major point of Weil’s paper is that these exceptions lead to an inconsistency that is misleading and distorting. He argues that in a world of perfectly rational agents, such budget accounting makes no difference. But since the real world seems to ,be myopic, he argues that the new budget treatment does affect decisions, and, in Weil’s view, does so in an inappro-

The Role of Market‐Value Accounting in Reducing Potential Taxpayer Subsidies: The Case of Deposit Insurance

The federal deposit insurance program required billions of dollars in taxpayer subsidies in recent years. Unless reforms are initiated soon, the program will continue to incur losses and will likely sizeable require subsidies in the future. Some of the blame for the past losses of the deposit insurance program has been attributed to the regulatory discretion and lack of information on the potential losses arising from the exercise of regulatory discretion. It is often argued that market‐value accounting can be an effective check on regulatory discretion and can minimize the future costs of the program to the taxpayers. This study examines the role market‐value accounting can play in reducing the potential taxpayer subsidies to the program. It examines the relationship between accounting system and losses to the deposit insurance program, discusses the problems in implementing the market‐value accounting, and shows how market‐value accounting can improve the effectiveness of the system of public regulation and reduce the adverse financial consequences of regulatory discretion. While the direct focus of the article is on the deposit insurance reform, the discussion and the arguments have applicability to improving the regulatory effectiveness of other public agencies and programs.