Deposit Insurance: A Reconsideration

This paper undertakes a simple general equilibrium analysis of the consequences of deposit insurance programs, the way in which they are priced, and the way in which they fund revenue shortfalls. We show that the central issue in analyzing deposit insurance is how the government will make up any FDIC losses. Deposit insurance premia matter only in so far as they affect the level of implied FDIC revenue shortfalls. Moreover, local variations in the magnitude of FDIC losses will generically be irrelevant for the determination of any equilibrium quantities that affect agent welfare. However, large enough changes in these losses can “matter.” There is no presumption that keeping these shortfalls low is a “good idea.” Finally, we show that multiple Pareto-ranked equilibria can be observed. The potential for multiplicity of equilibriua may depend on components of FDIC policy. Our analysis provides counterexamples to the following propositions. (1) Actuarially fair pricing of deposit insurance is always desirable. (2) Implicit FDIC subsidization of banks through deposit insurance is always undesirable. (3) “Large” FDIC losses are necessarily symptomatic of a poorly designed deposit insurance system. (4) Risk-based deposit insurance premia can easily be used to reduce moral hazard problems associated with deposit insurance provision.