The purpose of deposit insurance is to ensure financial stability, as well as protect the interests of small investors. But with government guarantees in hand, bankers take excessive risks, driving up the chances of failure. Evidence suggests that these schemes increase rather than decrease the probability of financial crises. There is a good chance that deposit insurance does more harm than good. This article surveys the rationale for and history of deposit insurance, and discusses its consequences and possible alternatives.
KeywordsAssets and liabilities Asymmetric information Bagehot, W. Banking crises Banking industry Deposit insurance Excessive risk taking Federal Reserve System Financial intermediaries Financial market contagion Great Depression Lender of last resort Moral hazard Non-bank financing mechanisms Risk
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