Is Fairly Priced Deposit Insurance Possible?

Authors

  • YUK-SHEE CHAN,

  • STUART I. GREENBAUM,

  • ANJAN V. THAKOR

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    • University of Southern California, J. L. Kellogg Graduate School of Management, Northwestern University, and School of Business, Indiana University, respectively. For their many helpful comments, we wish to express our gratitude to Stephen Buser (the editor), an anonymous referee of this Journal, Arnoud Boot, Lawrence Benveniste, David Besanko, Sudipto Bhattacharya, John Boyd, Mark Flannery, Christopher James, George Kanatas, Edward Kane, Anthony Saunders, Larry Wall, and participants at the 1988 Garn Institute Symposium and workshops at the Federal Reserve Bank of Atlanta, University of Florida, and Tulane University. The usual disclaimer applies.

ABSTRACT

We 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. We 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.

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