The Case for Abolishing Deposit Insurance Limits

Presentation by our new Adjunct Research Professor Jay Cullen.

Open for all interested.

Abstract

This article argues that government insurance for bank deposits should be unlimited. I argue that the debates concerning the ‘moral hazard’ associated with deposit insurance are much more convincing in theory than practice. As I will outline, there is scant evidence that monitoring by depositors increases with lower deposit guarantees. There is also little evidence that in developed jurisdictions with strong regulatory institutions, that deposit insurance results in excessive risk-taking on the part of banks.

In contrast, an extension of public guarantees in exchange for further restrictions on bank activities – warranted by the hybrid public-private nature of banking activities – would enhance financial stability. In contrast, as I will show, the positive consequences of placing legal limits on bank deposit coverage – aside from the elimination of depositor runs – are often overlooked, in particular the emergence of bank-like financial intermediation services outside both the regulatory and safety nets. As I will argue, the principal financial stability benefit from an extension of deposit guarantees would therefore be the immediate diminishing of the necessity for many parts of the so-called ‘shadow banking’ system. It would also almost certainly lead to lower speculative trading volumes on secondary markets, which have generated several episodes of systemic financial instability in recent years.

The article acknowledges there would be tradeoffs in the introduction of such a guarantee, including potential effects on government bond markets and monetary policy. I address such concerns throughout, as well as outlining activity restrictions which would accompany a lifting of the deposit guarantee cap. I conclude by arguing that whilst some costs would arise – a potential increase in moral hazard being one of them – such costs may be mitigated, and in any case likely not as significant as those posed by current institutional arrangements.

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Coffee and tea will be served.
You may bring your lunch packet!

 

Published Jan. 23, 2019 3:08 PM - Last modified Feb. 13, 2019 10:42 AM