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Deposit insurance subsidies, moral hazard, and bank regulation

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Abstract

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 premiumlinked subsidy behaves differently under risk-adjusted and fixed-rate premiums. The model also indicates that the implementation of a riskadjusted 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.

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Authors and Affiliations

  1. Loyola University of Chicago, 60611

    Chandrasekhar Mishra & Jorge L. Urrutia

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  1. Chandrasekhar Mishra
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  2. Jorge L. Urrutia
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Mishra, C., Urrutia, J.L. Deposit insurance subsidies, moral hazard, and bank regulation. J Econ Finan 19, 63–74 (1995). https://doi.org/10.1007/BF02920215

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