Very-low Risk Research Articles

Deposit insurance subsidies, moral hazard, and bank regulation

The model developed in the paper separates deposit insurance subsidies into two components: a premium-linked subsidy which arises from an ex-ante mispricing of the deposit insurance premium, and an asset-linked subsidy which arises from a lack of ex-post monitoring of the bank's actions. The identification of these two subsidies provides important insight into the relation between deposit-insurance subsidies and bank risk. The asset-linked subsidy is higher for banks of average risk and lower for very-high and very-low risk banks. The premium-linked subsidy behaves differently under risk-adjusted and fixed-rate premiums. The model also indicates that the implementation of a risk-adjusted insurance-rate schedule alone would not be sufficient to eliminate the bank's excessive risk-taking behavior. Thus, some combination of risk-sensitive deposit-insurance pricing and regulatory control is necessary to reduce the moral hazard problem.