Deposit Insurance and Its Design: A Literature Review

This paper reviews the main results of the economic literature explaining the existence of deposit insurance in its modern form. It is shown that deposit insurance is not the only means to cope with the problem of bank runs. Yet it is a prevailing solution for the banks dominate the credit channels in most economies the world over, and the modern payment systems are based on the convertibility of the bank deposits into cash. Being a part of the general public policy of financial sector stability, deposit insurance is structured in accordance with a core objective adopted for the entire policy, and this explains why many world schemes, besides the intrinsic DIS objective of bank run prevention, also choose to follow the objective of small (unsophisticated) depositor protection. In practice, a trade-off between the ability of a DIS to prevent bank runs and the soundness of incentives it induces forces policymakers to choose between the two objectives. The review of the related literature helps to distinguish four basic approaches regarding the balance of the run-prevention capacity and sound incentives in deposit insurance design. Further analysis also shows that three of the basic structuring options (the limited, partial, and selective guarantees) are likely to be employed in the ordinary (non-crisis) circumstances and the choice among them needs to be based on the country-specific factors. * Postdoctoral Fellow, Faculty of Economics & Faculty of Business and Commerce, Keio University The 21 Century Center of Excellence Program Faculty of Economics and Faculty of Business and Commerce, Keio University 2-15-45 Mita, Minato-ku, Tokyo 108-8345, Japan Deposit Insurance and Its Design: A Literature Review