The authors survey the literature on the characteristics of a bank and highlight some implications for asset and liability management and for the principles of banking supervision. They put special emphasis on deposit insurance. They also examine the motivations and drawbacks of the U.S. deposit insurance system and then assess selected proposals of reform for the system, which have had a bearing on the recent evolution of deposit protection schemes in other industrialized countries.

The authors maintain that federal deposit insurance practices differ significantly from private insurance practices. Indeed, federal deposit insurance is not insurance in the normal sense of the word. It is a guarantee that all insured depositors will be fully protected against loss. Flaws in the federal deposit insurance system have permitted insolvent thrift institutions to remain open. The very poor performance of these institutions masked the performance of solvent thrift institutions and drew attention away from the potential value of the thrift charter.

Analyzes the current and prospective condition of commercial and savings banks in the United States. Frames the major economic and policy issues raised by the banking crisis. Considers the current reported condition of the banking industry, concentrating on large banks. Presents a longer-run prognosis for the banking industry and discusses the implications of these projections for the financial services sector and for federal regulatory policy toward that sector. Assesses the condition of the Bank Insurance Fund, which is administered by the Federal Deposit Insurance Corporation. Presents and discusses alternative methods of financing the payment of the potential liabilities. Concludes with suggestions for changes in the nation’s deposit-insurance system and accompanying banking laws. (ã 1999 EconLit)

The authors trace the evolution of the federal deposit insurance system, discussing the initial legislated insurance assessment, subsequent changes in it, and the level of basic insurance coverage for the FSLIC and the FDIC. For both of the deposit insurance funds, data are provided on the reserves and on costs incurred. Much of the discussion is about the reserves at each fund in comparison with actual cost experience. For the FSLIC the authors find, in retrospect, that the insurance assessment did not increase rapidly enough when reserves relative to insured deposits fell.

This paper studies the record of the nineteenth and twentieth centuries and suggests that international financial rescues of the past were quite different from the series of bailouts during the 1990s. The international rescues of the 1990s marked a watershed in the purpose, size, and term of the funds provided to countries in distress. These recent bailouts were justified, however, on the grounds that they would stop the financial crisis from spreading to other countries.

In evaluating the performance of various government-created liability insurance schemes, the author asks two principal questions: First, which experiments failed or succeeded, and why? More particularly, the author attempts to ascertain whether the failures of insurance systems were attributable to a flaw inherent in their design or to insurmountable exogenous shocks. Second, would branch banking (a perceived alternative to insurance) have provided a more effective way to protect the payments system than bank insurance? The author concludes that unlimited branch banking combined with privately administered insurance programs would protect the payments system from exogenous disturbances that could produce banking panics.

This article considers possibilities for deposit insurance reform in the light of historical successes and failures of bank liability insurance in the United States. The author address four central questions: What was the historical motivation for bank liability insurance? Is this motivation justified by the historical record? Which safety nets for bank liability holders were most successful, and why? What are the lessons of the historical record for current reforms?

This paper explains how and why federal deposit insurance was adopted with near unanimity in 1933. The authors consider the forces for, and against, federal deposit insurance from the nineteenth century to 1933. They argue that even though the traditional supporters of federal deposit insurance had suffered repeated defeats and their power was at its nadir in 1933, the nature of the political struggle over deposit insurance changed in the 1930s: instead of being a battle waged in Congress among special interests, it became one that engaged the general public. The banking collapse focused the attention of the public on the otherwise esoteric political issue of banking reform and offered supporters of deposit insurance the opportunity to wage a campaign to convince the public that federal deposit insurance was the best solution to banking instability.

This book examines the relation between banks and deposit insurance schemes, analyzes the economics of banks, and discusses the role of deposit insurance within the safety net established in most countries to stabilize the banking system. Considers the rationale for deposit insurance, discussing both banking panic models and systemic risk as a source of financial instability. Examines the fundamental dilemma of deposit insurance, discussing the moral hazard problem, the social costs of moral hazard, and regulation and supervision as responses to deposit insurance. Analyzes various proposals for coping with the perverse effects of deposit insurance, including risk-related pricing of deposit insurance, solutions calling for greater reliance on market discipline, the possibility that market efficiency can be enhanced by increased information disclosure, use of a risk-related capital regulation, and radical alternatives that argue for a private deposit insurance and for narrow banks. Presents a comparative analysis of deposit insurance schemes across various countries, including the United States, Canada, Japan, the United Kingdom, Italy, France, and Germany. (ã 1999 EconLit)

In this collection of essays, the author examines financial institutions, credit market imperfections, financial intermediation, and the theory of deposit insurance. He also examines deposit insurance in a variety of countries, discusses the criticisms of deposit insurance, and suggests a system to prevent moral hazard.

The author defends his earlier opinion that share capital can reassure depositors of the safety of their deposits and can provide an alternative and probably superior means of protecting the banking system against problems caused by bank runs. He explains why Hazlett’s claim that the banker must necessarily make zero profits is incorrect and why her assertion that the pledge of capital is unlikely is mistaken.

FIRREA (1988) required the FDIC to review the pass-through deposit insurance coverage provided to individual participants in pension and profit-sharing 401k plans, as well as to individual investors in unit investment trusts. This is the final report.

Conference proceedings include topics such as Innovation in Financial Markets; The Superregional Challenge; FIRREA: Implications for the U.S. Financial System; The Future Role of Commercial Banks in Commercial Lending; Interstate Acquisitions; Japanese Banks: Emerging Global Competitors; Europe 1992; and Globalization and Public Policy. Specific papers related to deposit insurance include "Risk-Based Deposit Insurance: Is Price Regulation Necessarily Better Than Quantity Regulation?" by William R. Keeton; "Market-Based Deposit Insurance Premiums," by Kathleen A. Kuester and James M. O’Brien; "The Impact of Deposit Insurance on S&L Shareholders’ Risk/Return Trade-offs," by Elijah Brewer III; "Deposit Insurance and Risk-Shifting Behavior of Commercial Banks," by Jin-Chuan Duan, Arthur F. Moreau, and C. W. Sealey; "Post-FIRREA: The Need to Reform the Federal Deposit Insurance System," by James R. Barth; and "FIRREA: Implications for the U.S. Financial System," by Bert Ely.

Conference proceedings include topics such as The Condition of the FDIC; Assessing Current Legislative Proposals for Deposit Insurance Reform; Moral Hazard and Franchise Value: Theory and Evidence; Managerial Incentives and Bank Performance; Behavior of Poorly Capitalized Banks; Creditor Discipline, Bank Closure Policy: The Case for Early Intervention; FDIC Premiums; Market Value Accounting; and Future Bank Profitability. Papers on deposit insurance include "The Condition of the Bank Insurance Fund: A View from Washington," by Gillian Garcia; "Assessing the Condition of the Bank Insurance Fund," by Philip F. Bartholomew and Thomas L. Lutton; "Comments on Deposit Insurance Reform," by Thomas C. Theobald; "Dissecting Current Legislative Proposals for Deposit Insurance Reform," by Edward J. Kane; "Assessing the Current Legislative Proposals for Deposit Insurance," by John C. Dugan; "The Impact of Reform on Community Banks," by Kenneth A. Guenther; "The Asset Flexibility Option and the Value of Deposit Insurance," by Peter Ritchken, James Thomson, Ramon DeGennaro, and Anlong Li; "Dealing with Poorly Capitalized Banks from the Perspective of the Deposit Insurance Agency," by George J. Benston; "Subordinated Debt Market Information and the Pricing of Deposit Insurance," by Carolin D. Schellhorn and Lewis J. Spellman; "Reforming Deposit Insurance: The Danish Case," by Randall J. Pozdena; "A Simple Approach to Better Deposit Insurance Pricing," by Sarah B. Kendall and Mark E. Levonian; and "Deposit Premiums of Failed Banks: Implications for the Values of Deposits and Bank Franchises," by James A. Berkovec and J. Nellie Liang.

Conference proceedings include topics such as Regulatory Intervention; Interest-Rate Risk and Capital Requirements; Inside Information and the Allocation of Credit; Deregulation and the Changing Role of Banks; The Credit Crunch; Consolidation in the Banking Industry; The Japanese Banking System; and The Insurance Industry in Transition. Papers on deposit insurance include "Incentive Conflict in Deposit-Insurance Regulation: Evidence from Australia," by Edward J. Kane and George G. Kaufman; and "Bank Failure Resolution, the Cost Test, and the Entry and Exit of Resources in the Banking Industry," by Frederick S. Carns and Lynn A. Nejezchleb.

Conference proceedings include topics such as Systemic Risk; Estimating BIF Losses; The Response of Banks to Capital Shocks; Risk-Taking by Banks; Bank Accounting Issues; Bank Lending Practices; Bank Mergers; Bank Closure Policy; Banking in the Global Market; FDICIA: Renaissance or Requiem? and Bank Regulation after FDICIA. Papers related to deposit insurance include "FDICIA and the Future of Banking Law and Regulation," by Alan Greenspan; "The Importance of Accurate Bank Accounting under FDICIA," by Allen N. Berger; "A Moral Hazard Rationale for Early Closure in FDICIA," by Raman Kumar and George Emir Morgan; "Deposit Guarantees, Nonperforming Loans, and the Postal Savings System in Japan," by Thomas F. Cargill; "Politics of Deposit Insurance Reform: The Case of Argentina," by Geoffrey P. Miller; "The Implications of FDICIA for Bank Management," by Lawrence Connell; "Remarks on FDICIA," by William M. Isaac, "FDICIA: Renaissance or Requiem?" by George G. Kaufman; "Remarks on FDICIA," by Richard L. Thomas; "The Meaning of FDICIA," by Harrison Young; "New Private Sector Deposit Insurance," by Warren G. Heller; and "Remarks on Banking after FDICIA," by Karen D. Shaw.

Conference proceedings include topics such as Assessing Innovations in Banking; Strategies for Utilizing the New Tool Set in Banking; Derivatives and Risk Management; Lessons from Financial Crises; Mortgage Financing and Community Development; Responding to Bank Regulations; Interstate Bank Activity; Advances in Bank Cost Analysis; Financial Intermediation and Bank Uniqueness; Assessing and Monitoring Risk; Capital Regulation; and Expanding Bank Product Powers. Papers dealing specifically with deposit insurance include "Financial Innovations and Deposit Insurance," by Ricki Tigert Helfer; "Acquirer Gains in FDIC-Assisted Bank Mergers: The Influence of Bidder Competition and FDIC Resolution Policies," by Matthew T. Billet, Jane F. Coburn, and John P. O’Keefe; and "Banks’ Deposit Insurance Liabilities: Exogenous vs. Managerial Determinants," by Jin-Chuan Duan and C. W. Sealey.

The author discusses possible laissez-faire banking rules and procedures, as well as the defects of the rules and procedures in place. He contends that true laissez-faire banking will satisfy the stability-provisions demanded by orthodox economic theorists, thereby proving that deposit insurance is not necessary for bank stability.

The author examines several deposit insurance issues. He begins with the reduction of deposit insurance assessments almost to zero and asks how this could happen, why, and what it might portend. He then discusses the matter of privatization of the federal deposit insurance system, and includes some history not included in his preceding report (The Golembe Reports 1995-8).

Mention of federal deposit insurance evokes two disparate responses in today’s financial environment. Bankers and the public seem to view federal deposit insurance in an overall favorable light. While bankers are concerned about increased premiums, they don’t seem to favor major changes in our federal deposit insurance system. Business economists and the academic community, on the other hand, are far more critical of the current structure of federal deposit insurance. This paper examines today’s federal deposit insurance system by summarizing recent thinking in the area of perceived costs and benefits of federal deposit insurance. (ã 1999 EconLit)

This publication presents the IBAA’s analyses and positions on the following issues: (1) the purpose and history of federal deposit insurance; (2) monitoring and measuring risk; (3) incentives to control risk; and (4) closure or recapitalization of insolvent, or nearly insolvent, institutions.

Kane agrees with Wall on the basic elements of government deposit insurance, on its problems and prospects, and in particular on the costly role that political and bureaucratic incentives have played in keeping insolvent and inefficient institutions from being put out of business. However, Kane explains why he thinks the damage from the current deposit insurance system will be greater than Wall predicts.

In the late 1980s, small and large banks advanced very different proposals for changing the level of protection for depositors. Small banks favored covering all depositors regardless of the amount. In contrast, large banks preferred imposing some loss on large depositors when a bank fails. However, small and large banks have not always differed so sharply on deposit insurance. In the 1930s proponents tried to convince smaller banks that it was in their best interest to support deposit insurance, but most small banks ignored this advice and sided with larger banks against deposit insurance. In the 1980s, small banks rejected the proposals of large banks to reduce coverage of deposit insurance. This article argues that small banks have always needed deposit insurance more than large banks and opposed the idea in the 1930s only because of certain factors. Small banks need deposit insurance more than large banks because they lack diversification and are more susceptible to local economic shocks.

The high rate of bank failures and the sharp decline in the bank insurance fund during the late 1980s and early 1990s intensified debate over the best way to deal with poorly capitalized banks. Some banking experts and government officials have argued that government investment in the banking industry is the best solution because it minimizes the costs of bank failures to the FDIC and to society as a whole. This article presents the success of the Reconstruction Finance Corporation (RFC) during the Great Depression as evidence that the same approach would work today, but the article also maintains that government investment should be used with caution. The article describes how the preferred stock program came into existence and presents evidence that the program worked better than the more-recent prompt corrective action or forbearance have worked. Last, it considers the implications of the RFC experience for the deposit insurance debate in light of key differences between the 1930s and 1992.

This collection of 36 previously published papers examines the changing global financial scene. Deposit insurance topics includes "Financial Panics, Bank Failures, and the Role of Regulatory Policy," by Stephen Smith and Larry Wall; "Ex Ante Risk and Ex Post Collapse of S&Ls in the 1980s," by Elijah Brewer III and Thomas Mondschean; "Underlying Causes of Commercial Bank Failures in the 1980s," by Lynn Seballos and James Thomson; "FIRREA and the Future of Thrifts," by Elizabeth Laderman; "The RTC and the Escalating Costs of the Thrift Insurance Mess," by Christopher Pike and James Thomson; "FDICIA’s Prompt Corrective Action Provisions," by Christopher Pike and James Thomson; "Too Big to Fail: Origins, Consequences and Outlook," by Robert Hetzel; "Risk-Based Capital Standards and Bank Portfolios," by Jonathan Neuberger; "Early Warning Systems," by Mark Levonian; "The Effects of Interstate Banking," by Elizabeth Laderman; "Market Value Accounting for Commercial Banks," by Thomas Mondschean; and "Banking and Commerce: A Dangerous Liaison," by Loretta Mester.

This is a collection of previously published articles on financial intermediation. A majority of initial publication dates predate 1989. Deposit insurance papers include "Bank Runs, Deposit Insurance, and Liquidity," by Douglas Diamond and Philip Dybvig (1983); "Models of Banking Instability: A Partial Review of the Literature," by Kevin Dowd (1992); "Banking Theory, Deposit Insurance, and Bank Regulation," by Douglas Diamond and Philip Dybvig (1986); "Deposit Insurance: Theory and Practice," by Ian McCarthy (1980); "An Analytic Derivation of the Cost of Deposit Insurance and Loan Guarantees: An Application of Modern Option Pricing Theory," by Robert Merton (1977); "Federal Deposit Insurance, Regulatory Policy, and Optimal Bank Capital," by Stephen Buser, Andrew Chen, and Edward Kane (1981); and "The Reform of Federal Deposit Insurance," by Lawrence J. White (1989).

The author expresses concern that the S&L crisis could repeat itself on the banking stage and could result in a bailout costing over twice as much. He then strongly encourages the Treasury and Congress to take steps to prevent what he sees as the imminent collapse of the banking system.

Representatives from various countries met at the FDIC on September 26, 1990, to discuss alternative approaches to deposit insurance, bank-failure resolution strategies and the bank safety net. This paper summarizes the four panel discussions.

This report explains the economics of deposit insurance, summarizes laws and proposals for change, and provides a side-by-side comparison of the provisions that affect pension plans. Under 1991 law, the $100,000 insurance limit for individuals is applied on a per participant basis when a pension fund is involved. Legislative proposals with the general effect of scaling back these insurance protections have been introduced.

This article traces the evolution of the regulatory quagmire and takes a look at the policy options then facing Congress. Assessing these options requires an understanding of three trends in the financial-services industry. First, regulatory changes have largely removed the rationale for separate regulatory structures for banks and thrifts. Second, thrifts have become more like banks. And third, as banks have become healthier and a portion of the thrift industry has continued to falter, the premiums necessary to fund the SAIF have put thrifts at a competitive disadvantage.

The failure of the Rhode Island Share and Deposit Indemnity Corporation heightened the debate about mandating federal deposit insurance for credit unions. However, opponents of and proponents for required federal deposit insurance for credit unions relied primarily on anecdotal evidence to support their positions. This study provides empirical evidence concerning differences in the behavior of federally insured versus nonfederally insured credit unions in the United States in 1989. Results suggest that the problems occurring in Rhode Island are not symptomatic of widespread differences in the safety of the two groups of credit unions throughout the country. (ã 1999 EconLit)

During the 1980s, banks and thrifts failed at a rate the United States had not experienced since the Great Depression. Deposits at most of these institutions were insured by the federal government, and covering the insurance liabilities required over a hundred billion dollars in taxpayer funds. The crisis in the banking and thrift industries has led to a reexamination of the federal deposit insurance system. These pages are a collection of six essays (introduced and edited by Steven Russell) on deposit insurance and the federal government’s role in providing it: "Remarks on Banking and Deposit Insurance," by Philip H. Dybvig; "Deposit Insurance: A Skeptical View," by Kevin Dowd; "Banking without Tax-Backed Deposit Insurance," by J. Huston McCulloch; "What Have We Learned about Deposit Insurance from the Historical Record?" by David C. Wheelock; "Deposit Insurance: Problems and Solutions," by Mark D. Flood; and "Deposit Insurance Policy," by Anjan Thakor.

The authors explore the evolution of deposit guarantees in the United States. They also offer a comparative analysis of deposit insurance programs elsewhere in the world and review the reasons that 100 percent deposit guarantees have become an accepted policy norm for maintaining deposit market stability throughout the world. They argue, however, that the expanded role given the financial safety net has not minimized deposit market instability, but, instead, has contributed to and exacerbated financial-sector problems throughout the world. They conclude by arguing that changes are needed to allow bank deposit markets to function more freely and thereby improve the price-signaling mechanism for monitoring risk-taking in banking.

This article examines four important issues relating to the S&L crisis of the 1980s: (1) how the U.S. Congress postponed the necessary deregulation of the thrift industry for more than a decade; (2) how Congress tolerated, and legislated, the ballooning of the deposit insurance safety net; (3) why FIRREA fails to solve the problem; and (4) how some proposed changes will introduce market discipline to the deposit insurance system and help taxpayers police the growth of their "contingent liabilities" in this area.

Weil’s paper describes the U.S. budgetary treatment of direct loans and loan guarantees that began with the Credit Reform Act of 1990. Even though Taylor disagrees with Weil’s recommendation of returning to the old precredit-reform accounting, he stresses the importance of such research to U.S. federal budget policy and to economic performance in the United States and other countries.

History shows that banks are subject to runs and panics. Researchers disagree, however, about whether runs are contagious: that is, do problems at insolvent banks spread to solvent ones? If runs are contagious, what, if anything, can be done to stop the spread, and what are the implications for deposit insurance and banking regulations? In this article, Ted Temzelides reviews the basic theory and presents some recent evidence on contagious bank runs. (ã 1999 EconLit)

This article describes deposit insurance from a historical perspective and examines the record of state-sponsored deposit insurance. What emerges is a surprisingly consistent pattern: "reckless banking," losses in excess of assessments, increased assessments and borrowing, and the exit of sound banks from the insurance system, leaving an increasingly risky and ultimately uninsurable pool of remaining banks. In short, the history of deposit insurance funds shows that all have exhibited the same moral-hazard problem that was evident at the federal level in the 1980s.

This paper reviews some of the lessons to be learned from the experience of the original Reconstruction Finance Corporation (RFC), which was the principal government-funded bailout agency for both banks and nonbanks from 1932 to 1947. Having tried forbearance and seen it fail to deal adequately with the thrift industry’s problems after 1982, Congress created the Resolution Trust Corporation (RTC) in 1989, which it hoped would resolve those problems much as the RFC had done in the 1930s. According to the author, the RTC has proved to be a much weaker entity. He then discusses why creating an RFC would probably have been a better solution in the 1980s.

This report objectively explains the deposit insurance system in the United States: how it currently works (1990), how it originated and evolved, and why it exists as it does.

Witnesses include Charles Bowsher, Edward Kane, William Taylor, William Ferguson, Norman Jones, Timothy Ryan, and Lawrence J. White.

This report presents options for budgeting for the deposit insurance system within the federal government. The report’s major conclusions include the following: (1) cash accounting for deposit insurance has served the United States poorly; (2) costs should be measured as they arise rather than later when they are paid; (3) alternative methods are available to use these better cost estimates to improve deposit insurance accounting; (4) alternative means are available to control costs; and (5) phasing in a new system for deposit insurance budgeting can minimize transition problems.

The article focuses on the U.S. deposit insurance system partly because it is one of the oldest systems sponsored by a national government and partly because it is one of the most spectacular examples of what can go wrong with deposit insurance. The first section reviews the goals of deposit insurance and describes the methods used to limit bank risk. The second section discusses why deposit insurance has failed. The third section considers the costs of the breakdown. The fourth section analyzes the effectiveness and prospects for adoption of a variety of deposit insurance reform measures. Last, the article discusses the implications of the U.S. experience for deposit insurance systems in other countries.

The Credit Reform Act of 1990 required that starting with FY1992, loan guarantees—but not deposit insurance, Social Security, or any source of revenue—be budgeted on an accrual basis. Such accounting inconsistencies are neutral and innocuous in a world with optimizing rational agents and a tax-smoothing government, but they are not neutral and innocuous in a tax-weary policy environment. This paper argues, therefore, that the Credit Reform Act of 1990 should be rescinded and a pure cash-basis accounting principle be restored. A present-discounted-value accounting of the government’s activities could still be attempted, but off-budget and not solely for loan guarantees.

This article investigates interstate differences in banking market structure during the 1920s. It finds that the number of banks per capita and the ratio of state-chartered to federally chartered banks were highest in states with deposit insurance systems, low minimum capital requirements, and branching restrictions. In the 1920s, banking consolidation was greatest where falling incomes caused high failure rates, in states with deposit insurance, and where branching increased. After 1920, the high failure rate of insured state banks caused the ratio of state-chartered to federally chartered banks to decline relatively more in states with insurance systems. (ã 1999 EconLit)

The author argues that deposit insurance was the peculiar creation of the U.S. banking experience and, generated by some of that system’s worst features, is inappropriate for developing or transition economies. Deposit insurance not only presents enormous incentive problems but also demands additional regulations and close supervision to be workable in the short run. Simpler, less-costly alternatives may achieve the same objectives.

Without the Great Depression, the United States would not have adopted deposit insurance. This article examines how market and political competition for deposits raised the level of coverage and spread insurance to all depository institutions. The author explores the cost of insurance with a counterfactual analysis of an insurance-free post–Great Depression financial system in order to assess the burden imposed by the legacy of the New Deal.

The author explains why he believes (1) the FDIC will run out of insurance funds because of asset-quality problems at large banks; (2) banks will continue to fail because of bad loans; (3) the number of loan losses is cyclical, secular, and regulatory; and (4) the 1993 deposit guarantee system allows a bank to take the risks without paying a correspondingly higher price for funds.

The purpose of an accounting system should be to provide a depository’s managers, owners, and insurer-regulator with a picture of current economic reality so that private and public decisions concerning that depository have a power base. This article argues the case for market-value accounting primarily for thrifts and their insurance fund; but the basic argument and logic apply with equal force to commercial banks and credit unions and their insurance funds.

The objective of the Working Group is to develop concrete methods to strengthen financial systems in industrial and emerging-market economies alike. The first part of this report reviews existing sets of sound practices and ongoing efforts to formulate them, and goes on to consider the development of understandings on sound practices in certain areas where, had they existed, the Asian crisis could have been prevented, or its severity reduced. The focus of the second part is on concrete methods to foster implementation. The third and final part considers ways to better coordinate international efforts to strengthen financial systems. The appendix provides a list of ongoing and planned work in international forums that is related to the subject of this report.

A well-designed regulatory and legal framework in emerging markets will allow banks both to channel savings to enterprises efficiently and to play their role in corporate governance, while minimizing the vulnerability of the system to fraud, corruption, and financial crisis. The authors discuss issues in designing financial systems, including the goals of the financial system and deposit insurance.

Four strategies that should guide reform of the financial sector of transitional socialist economies are discussed: (1) building infrastructure, (2) privatizing some financial institutions early, (3) publicizing losses of state-owned enterprises, and (4) improving the tax system.

The authors examine the U.S. and European banking industries and derive and discuss lessons that each system could learn from the other. For example, European banks demonstrate how (1) expanded asset powers allow banks to diversify their sources of income and reduce their risk of failure, and (2) fewer geographical restrictions benefit banks, allowing them to better diversify their asset portfolios and reduce their risk of failure. From the U.S. experience, Europe can learn a valuable lesson, or warning: poorly constructed safety nets can reduce the incentives for, and the ability of, banks to monitor their own risks, with the result that there is less stability overall.

This book of essays by John U. Ebhodaghe offers insight into major developments in the Nigerian financial sector, particularly in the post–Structural Adjustment Programme era. Topics include deposit insurance, banking distress, bank receivership, bank management, bank internal-control systems, roles of banks’ external auditors, and the future of banking business.

Reviews the fiscal activities in a sample of 26 developing countries that governments have obliged their central banks to undertake. In the main, these activities fall under five categories: (1) collecting signage; (2) imposing financial restriction; (3) implementing selective credit policies; (4) undertaking foreign exchange operations at nonmarket-clearing prices; and (5) providing implicit or explicit deposit insurance at subsidized rates and recapitalizing insolvent financial institutions. Not all central banks engage in all these activities, but some central banks perform additional fiscal activities such as collecting taxes and running food procurement programs. (ã 1999 EconLit)

This paper contrasts deposit protection with other forms of insurance, examines why goods and services of all kinds receive warranties and guarantees, and explores the particular characteristics of deposits and banks that merit deposit insurance. It examines a variety of reasons why countries choose to adopt systems of deposit insurance, the pitfalls that can arise from poorly designed schemes, and the features of a scheme that successfully avoids these pitfalls. (ã 1999 EconLit)

Suggestions are made for the best deposit insurance systems in normal times and during emergencies. A well-designed insurance system needs to build good incentives for owners, managers, depositors, borrowers, regulators, and politicians.

This article explores the goals for a deposit insurance system, the tools of deposit insurance, best practices for the design of a system, and the effects of a poorly designed system. The author concludes that a well-designed deposit protection scheme can strengthen incentives for good governance for banks, but a poorly designed system will impair market discipline and lead to a deterioration in the banking system.

Governments must tread a fine line between ensuring the health of the banking system and encouraging recklessness on the part of individual banks (by overprotecting deposits). Ill-conceived deposit insurance can harm an economy if the scheme stifles innovation and economic growth. A deposit insurance system created in accord with both market and regulatory discipline can reinforce managers’ efforts, thereby helping the banking system work efficiently.

This chapter from the conference proceedings proposes a set of best practices for deposit insurance systems in normal times and during emergencies. These best practices draw on recent experience in dealing with financial crises around the world but are also influenced by the emphasis that modern finance theory places on good incentive structures for financial soundness. The chapter also examines departures from best practices, as revealed by an International Monetary Fund survey of 50 deposit insurance systems.

This paper surveys the characteristics of explicit systems of deposit insurance in 68 countries. It compares these actual practices with a set of best practices that has been adopted by IMF staff for advising member countries. These best practices seek to establish a system of deposit insurance that provides incentives for all parties to keep the financial system sound. The paper discerns some convergence toward best practices in recent years but notes several areas where improvements in the incentive structure are still necessary.

In Italian without English summary.

This paper investigates whether monetary policy and banking supervision should be separated. The main argument for separation is that the combination of functions might lead to a conflict of interest. An argument against is that separation is inconsistent with the central bank’s concern for the systemic stability of the financial system. In a cross-country survey of 104 bank failures, the authors observe a trend toward using taxpayers’ money for bank rescues, a trend that strengthens the case for splitting off the supervisory function to another government agency. It would, however, be difficult to have a separation, since the central bank generally remains the only source of immediate funding for bank rescues.

Deposit insurance can contribute to financial stability, but only if it is adequately funded and if other safeguards—such as a strong bank supervision program—are also in place. On the surface, it appears that a national deposit insurance system can be set up quickly and easily, with the announcement of a public guarantee of bank deposits. Some countries, hoping both to prevent wholesale deposit withdrawals that could cause healthy banks to fail and to bring stability to a troubled banking system, have tried to create a deposit insurance system in just this way. Unfortunately, unless the system has sufficient financing to ensure its survival in a serious financial crisis as well as a strong program of bank supervision, it is destined to fail.

Despite explicit federal legislation forbidding the combination of commercial banking and commerce, through corporate ownership it is possible under 1993 law to combine two kinds of banks with nonbanking activities. Continuing efforts to encourage these mixtures may be patterned on industrial banks or nonbank banks, whose operations are favorable for owners such as insurance, securities, or industrial firms.

In any representative democracy, public officials are subject to incentive conflict. Japan can benefit from understanding and eliminating the particular conflicts in bureaucratic incentives that make U.S. regulators reluctant to acknowledge and resolve deposit-institution insolvencies in a timely fashion. Weaknesses in accountability for the delayed consequences of regulatory decisions tempt regulators to help inefficient and insolvent banks to resist exit at the expense of other parties. To improve incentives, the consequences of regulatory choices must be made transparent enough for outsiders to monitor them. This can be done by assigning responsibility for privately insurable risks to private coinsurers and defining more fully government responsibilities for monitoring and minimizing financial institutions’ exposure to catastrophic risk. (©1993 Academic Press)

This article identifies some ethical constraints and patterns of privatization that promise to increase the efficiency and fairness of federal deposit insurance. The problems of deposit insurance show that congressional oversight of discretionary government loss-control is a system that continues to misserve taxpayer interests. The author outlines reform models that would constrain regulators and politicians to treat taxpayers’ loss exposure more nearly as if it were their own.

Unlike the Federal Savings and Loan Insurance Corporation and the Bank Insurance Fund, the National Credit Union Share Insurance Fund (NCUSIF) survived the 1980s without falling into a state of accounting insolvency. This paper analyzes how differences in incentive structure constrain the attractiveness of interest-rate speculation and other risk-taking opportunities to managers and regulators of credit unions. Despite these better incentives, robust present-value calculations establish that NCUSIF fell into economic insolvency during the mid-1980s. Besides calculating the extent of this insolvency, the paper also seeks to explain why, after NCUSIF became insolvent, it could rebuild its reserves without an explicit or implicit taxpayer bailout. The authors’ explanation turns on cross-industry coinsurance responsibilities and the shallowness of the fund’s observed insolvency relative to industry net worth. We identify forces in the decision making environment tending to limit the depth and duration of unresolved insolvencies at individual credit unions. The authors conjecture that expanded use of coinsurance and private monitoring could reduce taxpayer loss exposure elsewhere in government deposit insurance systems. (ã 1999 EconLit)

This paper discusses deposit insurance and failed-bank resolution systems: the role they play in a nation’s financial safety net; the advantages and disadvantages such systems provide; the establishment, coverage, and funding of such systems; the linkage with supervision and licensing; and failed-bank receivership and resolution processes and considerations. Although deposit insurance systems are in place in many countries, this paper is based heavily on the lessons learned from, and on the principal features of, the deposit insurance system in the United States.

This study highlights the difficulties inherent in designing an optimal bank regulatory policy. When banks can issue equity at the risk-adjusted risk-free rate, collateralization of deposits with a risk-free asset costlessly resolves moral-hazard inefficiencies and insurance pricing issues. Heavy information requirements inhibit incentive-compatible designs in obtaining optimal bank-specific results.

This handbook aims to give practical guidance on the essential questions that must be addressed in the establishment of deposit insurance schemes. It examines the rationale for deposit insurance, given the risk that insurance creates moral hazard. It then discusses the differences between formal deposit insurance schemes and implicit (or ad hoc) arrangements for depositor insurance, and the feasibility of private insurance. After describing different types of schemes, it deals with detailed matters such as triggers for the payment of compensation, selection of the categories of deposit that are to be protected, compensation ceilings, and co-insurance. Finally, it discusses the financing of compensation and of administrative arrangements.

As conditions in developing countries have become highly unstable, the affected governments have taken a variety of actions to restore stability to their banking systems. One such action has been to establish deposit insurance. This article contrasts explicit and implicit systems of deposit guarantees, explains the pros and cons of each insurance scheme, and details how best to design an insurance system.

This article demonstrates that most of the criticisms of federal deposit insurance were well understood and warned about at the time of its inception, thus it is difficult to explain the guarantee nature of the plan by an earlier lack of understanding. The moral hazard problem had in fact been explicitly detailed by the early 1920s and regulatory forbearance was experienced and discussed by the early 1930s. Even proponents of deposit insurance were especially critical of the guarantee feature of the plan. Moreover, earlier remedies and alternatives match closely those advocated today. (ã 1999 EconLit)

This article examines why the government provides deposit insurance and how the provision of deposit insurance can improve economic performance. The author argues that the primary reason for deposit insurance is to promote financial stability by preventing bank runs. He points out, however, that deposit insurance may allow excessive risk-taking, and the costs of possible misallocation of resources associated with excessive risk-taking must be balanced against the benefits of financial stability. The terms of this trade-off depend on the availability of alternatives to bank deposits as sources of liquidity, the importance of bank lending activities, and the difficulty associated with monitoring bank asset values and monitoring risk-taking. Finally, the author considers alternatives to, and reforms of, deposit insurance.

The 1989 failure of the Rhode Island Share and Deposit Indemnity Corporation (RISDIC), a private insurance fund, and the closure of its 45 remaining member institutions froze the accounts of 300,000 individuals—10 percent of all deposits in the state. Although the closure of two institutions triggered RISDIC’s demise, flaws in both design and management had set the stage for failure and are the focus of this article. The authors group RISDIC’s problems into three categories: risk concentrations, control of the insurance fund by those it insured, and RISDIC’s inadequate regulatory oversight of members. Concentrations of risks abounded. Both the fund and the geographic area it covered were small, and member institutions lent heavily in real estate. The fund’s failure to reserve sufficiently against this exposure was especially problematic.

This paper presents a selective survey of deposit guarantee programs. First, it reviews the establishment of programs guaranteeing bank accounts in several countries and puts them in historical context. Second, the paper analyzes the intended purposes of a deposit protection program. The usefulness of a protection program and its role in the safety net for the banking system become clearer when one recognizes that reorganizing a failing bank is preferable to closing it down and that a deposit insurance fund may provide the resources needed to expedite an assisted merger or a recapitalization. Third, a deposit protection program, while intended primarily to maintain order and safety, has secondary and sometimes subtle effects on the banking sector.

This paper analyzes the difficulties associated with bank regulation and deposit insurance in a unified Europe. Specifically, it explores the consequences of the Second Coordinating Banking Directive and the "common passport" branching regulation. The paper analyzes issues of deposit insurance premiums and taxes on banks (including reserve taxes) in the context of a general equilibrium model. The results indicate that in such a structure, taxes and deposit insurance are interdependent. At the minimum, exceedingly close macroeconomic policy coordination will be necessary if the single market for financial services is truly to come to fruition and be stable. A similar degree of cooperation will be necessary in the area of bank regulation.

The U.S. Treasury Department (1991) makes a strong case for consolidating federal bank regulatory authority. However, its proposal to eliminate direct FDIC authority over insured nonmember banks contributes little to this end because deposit insurance requires supervisory oversight. The U.S. Treasury Department (1991) also maintains an independent role for the Federal Reserve. Elimination of neither the insurance agency nor the central bank appears practical. A better approach to regulatory agency consolidation would combine supervision with deposit insurance and central banking in an institutional structure modified somewhat from the present Federal Reserve structure. (ã 1999 EconLit)

This article first analyzes and evaluates the implications and desirability of creating a deposit insurance system in countries that do not already have such systems. It then identifies the major features of deposit insurance systems and reviews the pros and cons of alternative structures for each major feature.

This economic commentary analyzes the collapse of the Rhode Island Share Deposit Indemnity Corporation (RISDIC) with a view toward differentiating between the elements of failure and resolution that RISDIC shared with other large state-chartered deposit insurance funds—principally the Ohio and Maryland funds—and the elements that were unique to Rhode Island. Also examined are the factors that led to differences between the solution chosen by state and federal officials in Rhode Island and the solutions used in Ohio and Maryland. Finally, the author draws inferences from these episodes for the design and viability of private deposit insurance plans.

The optimal provision of loan guarantees or deposit insurance is examined in the context of an overlapping generations model. He demonstrates that even in the face of a market imperfection that precludes diversification of the private sector’s loan portfolio to eliminate risk, full government guarantee of private sector loans (or deposits) is suboptimal. The results suggest that although some degree of guarantee is appropriate, such policies should be designed to avoid an inefficient level of capital accumulation. (ã 1999 EconLit)

The standard asset-pricing paradigm is applied to measure a credit rating agency’s implied rating standards, such as leverage and asset volatility, from observed bond yield spread data. A methodology is proposed to measure the amount of debt that a firm needs to reduce in order to enhance its credit quality (bond rating) without changing its asset risk and size. This methodology is applied to develop implementable bank capital and deposit insurance premium standards based on ratings of pools of bonds held by banks in equilibrium within a paradigm (an alternative to narrow banking and consistent with universal banking) in which regulators act like private surrogates of bank debtholders, insuring debt for a price but not for profit, and banks choose their asset composition. (ã 1999 EconLit)

This paper shows that leaving insolvent banks with large enough charter values open can be optimal and derives normative bank closure/reorganization policies based on the liquidation value of assets and the charter value. The charter value of a bank is broadly defined as the value that would be foregone due to a closure. Our simulations of risk-taking show that an optimal forbearance for an insolvent bank with a large enough charter value alleviates the moral hazard problem. This is because increasing the risk raises the probability of losing the charter value, although it generates a moral hazard gain. (ã 1999 EconLit)

Optimal dynamic regulatory policies for closing ailing banks and for deposit insurance premiums are derived as functions of the rate of flow of bank deposits and interest paid on deposits, the economy’s risk-free interest rate, and the regulators’ bank audit/administration costs. Under competitive conditions, the threshold assets-to-deposits ratio below which a bank should be optimally closed is shown to be greater than or equal to one. Optimal deposit insurance premiums and probabilities of bank closure are shown to be nondecreasing in the bank’s risk on investment and nonincreasing in the bank’s current assets-to-deposits ratio. (ã 1999 EconLit)

Previous research evaluating deposit insurance as a put option has ignored the ability of the deposit insurer (put writer) to control the timing of the puts exercise via closure decisions. We model deposit insurance as a callable put, i.e., a put option where the FDIC retains a valuable call provision. The value of deposit insurance subsidies can therefore be measured as the net difference between the put and call features of the insurance contract. Forbearance can be viewed as forfeiture by the deposit insurer of the value of its call component of the deposit insurance option. (ã 1999 EconLit)

This report argues that the direct costs of raising deposit insurance premiums will increase FDIC case resolution costs by increasing the number of bank failures and reducing the present value of failed banks to potential acquirers. Indirect effects—although less obvious—are also important. Raising premiums will reduce credit availability and slow the economic recovery. In turn, the slower recovery will result in additional bank failures and an even greater burden on the BIF.

The authors use the theory of the term structure of interest rates and the pricing of interest-contingent contracts to determine the fair value of insurance for depository institutions. The balance sheet of a bank is taken to consist of long and short positions in various fixed-income securities. Deposit insurance for the bank is a put option on the value of the assets. The value of deposits, assets, and implied exercise price of the put and the value of the put are all determined simultaneously as part of the same valuation solution. The approach is initially developed for a single-state term structure and is then extended to incorporate credit risk on bank assets.

In this article the authors examine the information that stock prices provide about the financial condition of federally insured thrift institutions. In order to assess their financial condition from the different perspectives of stockholders and the federal insurer, they calculate the value of the put option of federal deposit insurance available to thrift institutions. Their results demonstrate that the two perspectives often provide, particularly for unhealthy institutions, quite different views of the financial condition of individual institutions. (ã 1999 EconLit)

The authors address the question of whether to revise the current system of flat-rate deposit insurance premiums in favor of a risk-based system. Although there is general agreement that relating an insured bank’s premium to the risk it poses to the insurance fund would be desirable, the information-intensive nature of the intermediation process in which banks specialize makes risk measurement difficult. The authors present an overview of alternative methods for establishing risk-based premiums and then discuss the arguments for and against risk-based premiums.

The authors analyze risk-sensitive, incentive-compatible deposit insurance in the presence of private information and moral hazard. Without deposit-linked subsidies, it is impossible to implement risk-sensitive, incentive-compatible deposit insurance pricing in a competitive, deregulated environment except when the deposit insurer is the least risk averse agent in the economy. The authors establish this formally in the context of an insurance scheme in which privately informed depository institutions are offered deposit insurance premia contingent on reported capital; the result holds for alternative sorting instruments as well. This suggests a contradiction between deregulation and fairly priced, risk-sensitive deposit insurance. (ã 1999 EconLit)

The author estimates the market value of deposit insurance for a sample of savings and loans associations, using various methods that can be applied to S&Ls that do not have publicly traded stocks. For each S&L, deposit insurance is priced as a one-period European put option with a striking price equal to the book value of the S&L’s liabilities. Previously this method of pricing deposit insurance has been applied to banks and S&Ls that do have publicly traded stocks. The author shows how the market value of assets and asset volatility can be obtained from the S&Ls’ accounting data by several methods. The results of this study suggest that it is feasible to price deposit insurance premiums using accounting data. The results further suggest that under the fixed-rate deposit insurance system, significant cross-subsidization among S&Ls was evident during the 1990s.

There is a widely held impression that federally insured deposits are the risk equivalent of Treasury securities. Despite this impression, the authors provide evidence of risk pricing of insured deposits. If there is risk pricing of guaranteed deposits, investors in deposit instruments evidently price the possibility of loss from incomplete or costly deposit insurance coverage. The risk pricing of insured deposits is tantamount to believing the guarantee might be repudiated in whole or in part. This paper examines this issue in the context of premium rates found to exist for the FSLIC-insured deposits during that agency’s waning days before its abolition in 1989.

The authors examine the effect of a series of announcements leading to the approval of risk-based deposit insurance premiums on returns to stockholders of commercial banks. Utilizing risk-weighted capital ratios and measures of overall risk, we group banks according to one of the nine-tier insurance categories subsequently defined by the FDIC. During the period in which the new insurance system was considered and approved, it was found that stockholders of "well-capitalized," "healthy" banks experienced wealth changes significantly different from those experienced by less than well-capitalized, less than healthy banks. Although many argued the premium range in the initial insurance schedule was insufficient, the results show that this initial risk-basing marked an important change in the relative burdens imposed by FDIC insurance. (ã 1999 EconLit)

The thrust of current deposit insurance reform--risk-based insurance premiums and capital requirements--is an effort to price deposit insurance more fairly. Fairly pricing deposit insurance eliminates inequitable wealth transfers but it does not lead to an efficient equilibrium. This paper shows that an alternative charter policy results in an efficient separating equilibrium. (ã 1999 EconLit)

Previous research on deposit insurance and capital adequacy has modeled the bank as a corporate firm with risky assets and insured liabilities. No attempt was made to analyze explicitly the risk characteristics of bank assets. The purpose of this paper is to model bank lending and calculate credit-risk sensitive insurance premia. The lending function of banks creates the need to model equity as a "capped" call option. Previous estimates of insurance premia which are based on a "naked" call assumption could be biased. Moreover, it is shown that the Modigliani-Miller capital structure irrelevance theorem implies the ineffectiveness of bank capital regulations. (ã 1999 EconLit)

This dissertation examines two issues in the theory of banking: the role and efficiency of a monopoly bank in a spatial economy, and the design of a deposit insurance contract. Chapters 2 and 3 of the thesis develop and analyze a simple production economy with two types of agents. Lenders have an endowment of one unit of a good that may be consumed or invested in a firm. Firms have access to a project but lack the capital necessary to operate it and are thus forced to borrow: firms’ projects are identically independently distributed cross-sectionally. A simple information asymmetry prevents efficient contracting by lenders and firms and results in the incurring of deadweight default costs.

A multiperiod deposit insurance pricing model is developed in this article, which utilizes an asset value reset rule comparable to the typical practice of insolvency resolution by insuring agencies. The fairly-priced premium rate of our model can substantially differ from Merton’s (1977). After incorporating capital forbearance and moral hazard into the model, our results show that the fairly-priced premium rate is not neutral to forbearance policy even in the absence of moral hazard. The model formalizes the process of how excessive risk-taking under capital forbearance could lead to instability in the deposit insurance system. (ã 1999 EconLit)

The authors propose a multiperiod deposit insurance pricing model that incorporates simultaneously a capital standard and the possibility of forbearance. The model uses the recently developed GARCH (Generalized Auto Regressive Conditional Heteroscedasticity) option pricing technique in determining the deposit insurance value. The authors contend that their model offers two distinct advantages. First, it explicitly considers the implications of the strict enforcement of capital standards as stipulated in the FDIC Improvement Act of 1991 (FDICIA). Second, use of the GARCH model allows the authors to capture many robust features exhibited by financial asset returns. By the GARCH option pricing theory, the value of a contingent claim is a function of the asset risk premium. This unique feature is found to be prominent in determining the bank’s deposit insurance value. The model is also used to study the effects of capital forbearance and moral-hazard behavior in the multiperiod deposit insurance setting.

The many publications on various aspects of deposit insurance reform have failed to explain how the features of deposit insurance contracts affect bank decisionmaking; and they lack a clear prescription for formulating such contracts so as to achieve policy goals. This article develops a model of bank behavior under regulatory constraints within a framework of moral hazard. The results show that the policy goals pursued by regulatory authorities can be achieved only if deposit insurance contracts take into account incentive compatibility. One implication of the model is that, under existing (1993) regulatory policies, a ceteris paribus move to risk-adjusted deposit insurance premiums may actually make banks riskier. Some numerical results are presented to show the quantitative importance of the model’s implications.

The linkage between the interest-rate risk exposure of banks and the liabilities of a deposit insuring agency is not well understood. The authors develop a model to evaluate the interest-rate risk exposure of both deposit-taking institutions and deposit-insuring agents when bank equity has limited liability and interest rates are stochastic. Empirical results based on a sample of U.S. banks are presented for the interest-rate risk exposure of banks and for the effect of this exposure on the liabilities of the FDIC.

This study examines several empirical issues that must be addressed if the Contingent Claims Approach (CCA) is to be used to price deposit insurance. The author examines the difficulties of dealing with mutual associations, the proper setting of the term of the associations’ deposits, and the proper measure of the riskiness of those deposits. He devises procedures and structures them into a model that uses the CCA to price deposit insurance for all associations, not just associations with widely traded equity. This model also facilitates an analysis of the validity of the CCA. The study’s major result is that the default risk premiums developed for each association by the CCA were statistically similar to those measured in the market. This finding supports the use of the CCA in the pricing of deposit insurance.

The FDIC’s total liability for insuring a bank’s deposits during a fixed period diminishes as the frequency of examinations increases, since a marginally solvent bank can be closed while losses are small. This article develops a technique for pricing the insurance liability over a fixed period during which there are multiple examinations. Under 1996 regulatory policy, most banks are examined annually and reviewed every six months, at which time the fees for insurance may be adjusted. Since the existing schedule of fees allows only a narrow range and a few discrete levels, the FDIC typically retains some positive or negative residual liability in each six-month period and for the entire year. The authors show how to estimate this net liability. The calculations of total and net liability are illustrated for a sample of large banks.

In this FIRREA-mandated report, the FDIC reviews the framework for deposit insurance pricing methods and recommends procedures and an implementation strategy. Chapter 1 reviews the conceptual framework of deposit insurance pricing, examining several pricing issues as well as several alternative methods for establishing risk-based deposit insurance. Chapter 2 develops a proposal for risk-based deposit insurance that uses an adjusted capital approach. Chapter 3 presents the study’s conclusions.

The author compares the FDIC’s risk-related premium system with independent risk classifications derived from a proportional hazards model (PHM). The PHM estimates actuarially-fair insurance premiums on the basis of econometric estimates of expected time-to-failure. The author concludes that the FDIC’s relative risk rankings are generally consistent with those of the PHM as well as with historical failure rates. The premium rate spread between high- and low-risk institutions, however, is considerably narrower than what is suggested by the PHM.

If the deposit insurance agency ("FDIC") can observe bank risks without error, it can attain actuarial soundness equally well with either risk-related premium assessments or risk-related capital standards. However, many bank assets are difficult and expensive to evaluate, so their true value and risk cannot be ascertained without error. These risk measurement errors cause the FDIC to misprice its deposit insurance, which can be analyzed as a put option written on assets with uncertain volatility and current value. This paper evaluates the optimal means of pricing deposit insurance in such an environment. Because FDIC’s insurance pricing errors increase with bank leverage, the impact of these errors on private-sector allocations can be minimized with a combination of risk-related capital standards and risk related premia. (ã 1999 EconLit)

This paper critically examines the use of option pricing models for analyzing deposit insurance premiums. The author outlines the basic theory of option pricing, which was originally developed to assign dollar values to the option contracts traded on financial exchanges. Then, by applying the model to several insurance arrangements, he illustrates how to analyze the claims of bankers, depositors, and insurers on the assets of a bank or thrift. Finally, he considers some of the limitations of this approach.

This note elaborates on a recent contribution by Chan, Greenbaum and Thakor (1992) who argue that fairly priced deposit insurance is incompatible with free competition in the banking sector when adverse selection is present. We show that, under more general assumptions on the banks’ operating costs, there exist incentive compatible mechanisms that are fairly priced. However, we compute the characteristics of the optimal premium schedule and show that it is not fairly priced: instead it entails subsidization of the less efficient banks by the most efficient ones. We also analyze the trade-off between short-run and long-run efficiency: cross-subsidies help relaxing incentive compatibility constraints but generate unfair competition. (©1998 Academic Press)

This paper describes a new approach to pricing government deposit guarantees that uses techniques of stochastic process switching employed in the recent literature on exchange rate determination. Our model avoids inconsistent assumptions about the information available to investors and the government common in previous work based on an option pricing approach. We derive actuarially fair deposit insurance premia and optimal financial reorganization rules and examine the role of banking policies such as capital requirements. (ã 1999 EconLit)

The author expresses his concern about the immediate need for deposit insurance reform. He suggests (1) reducing deposit insurance coverage from $100,000 to $50,000; (2) abolishing the policy of "too big to fail"; (3) making insurance premiums paid by banks a function of risk; and (4) publishing the FDIC ratings of each bank for consumers to use when choosing a bank with which to do business.

Uses option valuation models to analyze the economics of a deposit insurance system. Provides an introduction to deposit insurance systems and a brief history of the Finnish deposit insurance system, describing how it has functioned and changed in the environment of the recent economic and banking crises. Presents a one-period European-type put option model of deposit insurance. Conducts comparative static analysis to identify the basic determinants in the value of a deposit insurance contract and their interactive effects. Provides an analysis of deposit insurance coverage as far as the various liability holders are concerned. Uses the one-period model for estimating the value of deposit insurance for those Finnish banks whose stock price information is available. Analyzes deposit insurance with a multiperiod American-style put option model, exploring bank risk incentives under various regulatory schemes, and calculating point estimates of the value of deposit insurance premia under various insurance schemes and assumptions of the stock market’s expectations concerning the regulator’s behavior. Licentiate thesis for the Helsinki School of Economics and Business Administration. (ã 1999 EconLit)

This study uses alternative pricing models from both the macro and micro viewpoints to estimate FDIC premiums. Then, using an option as well as a non-option approach, it estimates risk-based insurance premiums for banking firms. The study uses computer-accessed market data and FDIC Call Report data. The empirical results indicate that the FDIC overcharged banks for deposit insurance during the 1980s.

Logistic regressions are performed to estimate the probability of bank failure. The in-sample logistic regression analysis indicates that the higher the equity capital, profitability, or liquidity, the lower the probability of bank failure. On the negative side, the ratio of past due loans to total assets is the most stable factor contributing to bank failures over the sample period. Other failure contributing factors change over time. In addition, a numerical illustration is provided to calculate the actuarial fair deposit insurance premiums. (ã 1999 EconLit)

This paper is a survey of economic literature concerning the applications of the OPM (Option Pricing Model) to the banking firm. Firstly, the model was used for assessment purposes, namely to derive the fair deposit insurance rate and to measure the risk of the bank assets. Secondly, the OPM studied the capital structure problems, and the related banking strategies, especially the tendency of bankers to increase their risk-taking. These findings led to an anlysis of banking regulation, concerning the ways of rating deposit insurance and the definition of solvency ratios. Concluding remarks turn on the limits of the OPM, when applied to the banking firm, as it takes into account only the solvency risk, and ignores the liquidity risk. (ã 1999 EconLit)

This paper treats the fair deposit insurance premium as a fixed point of the value of insurance per dollar of deposits. Using the standard model of the value of deposit insurance and treating the premium as an up-front cost to a bank it is shown that the fixed-point premium exists and is unique under fairly general conditions. It is shown that ignoring the premium as an up-front cost may lead to underestimation of the fair premium. In addition, the fixed-point model suggests that premium rates should vary with the ratio of deposits to total liabilities. (ã 1999 EconLit)

The authors examine the ability of simple insurance pricing schedules to match premiums with the values derived from a contingent-claim model of deposit insurance. They use a quadratic loss function to compare a flat-rate pricing system to alternative pricing schedules incorporating measures of risk. A simple two-bracket schedule that distinguishes between high and low capitalization is a substantial improvement. A pricing schedule under which the rate paid by low-capital banks depends on their degree of undercapitalization is better still. In addition, the gains from using market value measures of capital rather than book value are great. (ã 1999 EconLit)

Using a pricing formula for options on coupon bonds, Jamshidian (1989), El Karoui and Rochet (1990), the authors compute the actuarial pricing of deposit insurance for a commercial bank. The formula takes into account the maturity structure of the bank’s balance sheet, as well as market parameters such as the term structure of interest rates and the volatility’s of zero coupon bonds. The relation with asset liability management methods is explored. (ã 1999 EconLit)

Risk adjusted deposit insurance premiums have been among deposit insurance reforms considered by economists and policy-makers. This paper evaluates the use of option pricing methods, used in a number of studies, to set stock market-based, risk adjusted deposit insurance premiums, and more generally, to identify banks by their riskiness. The paper points out potential biases in the approach, and it empirically tests the ability of the option measures to distinguish banks by risk. The results demonstrate that the equity market measures are sensitive to contemporaneous accounting information and have predictive power for future bank performance, but that the market measures do not contain all the information conveyed by accounting data. Thus, the results do not make a convincing case for exclusive use of this methodology to set risk adjusted insurance premiums. They suggest, however, that market and accounting information may be useful jointly in identifying risky banks. (ã 1999 EconLit)

The passage of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), which removed some of the freedom or latitude the FDIC had in resolving and closing insolvent institutions, makes it clear that regulatory closure rules are not invariant with regard to time and events. Therefore, this paper analyzes the effects of variations in the laxity or strictness of bank closure rules on the valuation of deposit insurance. Hardly predictable state variables, such as political, economic and bureaucratic constraints, represent potential sources of uncertainty that drive changes in the stringency of closure policy. A variation of Ronn and Verma’s model is extended to consider situations where the insurance agency’s closure rule is uncertain.