Chapter 15: Deposit Insurance (Sections 15.1–15.4) Flashcards
(10 cards)
What is the primary goal of deposit insurance?
To prevent bank runs by guaranteeing small depositors their money back if a bank fails, maintaining confidence in the banking system.
During the U.S. savings-and-loan crisis of the 1980s, deposit insurance kept retail customers from withdrawing funds en masse when troubled thrifts collapsed.
How does the fair-premium approach determine insurance fees?
Banks pay a fee equal to their expected losses—calculated as the probability of default times the insured deposit amount—so the fund can cover average payouts without subsidy.
A community bank with $100 M in insured deposits and a 2% annual failure risk would owe about $2 M a year in premiums.
What insight does the option-pricing view bring to pricing deposit insurance?
It treats insurance as a put option on bank assets: the insurer ‘buys’ bad assets at par value when the bank fails. Premiums must reflect asset volatility and leverage, not just default probability.
A bank heavily invested in volatile commercial real-estate loans pays a higher premium than one holding stable government bonds.
Why does deposit insurance create moral hazard for banks?
With depositor withdrawals insured, banks feel less pressure to monitor risk, leading them to favor high-return but high-risk assets because the downside is partly socialized.
Before 2008, some banks rapidly expanded subprime mortgage holdings, knowing depositors couldn’t trigger runs.
What is a correlation surcharge and why is it used?
An extra fee added when a bank’s loan portfolio is highly similar to its peers’. It covers the increased chance that multiple banks will fail together in a common shock.
Two regional banks focused on energy loans pay surcharges because an oil-price crash would hit both simultaneously.
How can co-insurance mitigate moral hazard in deposit insurance?
By requiring depositors to bear a small fraction of losses above insured limits, it keeps them attentive to a bank’s health and imposes market discipline.
Depositors might lose 10% of balances above the insurance cap if banks take excessive risks.
What does the public-funding rationale argue about who should bear insurance costs?
That society at large benefits from stable banking—through higher investment and growth—so general taxation (e.g., a small financial-transaction levy) can subsidize deposit insurance.
A tiny levy on stock trades funds the insurance pool, spreading costs across all market participants, not just bank customers.
How do countercyclical insurance premiums work?
Premiums rise during boom times when banks tend to take more risk and fall during downturns to avoid forcing fire-sales or credit crunches.
Regulators might double fees in a credit boom to discourage excessive lending, then cut them when markets tighten.
Why is risk-based premium differentiation important?
Charging each bank according to its individual risk profile (e.g., loan mix, leverage) aligns incentives: safer banks pay less, risk-seekers pay more.
A bank with a high proportion of speculative commercial property loans would face higher insurance rates than one focused on residential mortgages.
What real-world change followed the 2008 crisis regarding deposit insurance design?
Many countries loosened premium schedules to account for systemic risk, increased coverage limits temporarily to shore up confidence, and introduced risk-weighted premium systems to better reflect individual bank risk.
