Deposit Protection

July 31, 2024
10:00 pm

In this presentation we analyze deposit insurance, a system implemented to protect bank depositors from losses in the event of a bank failure. Deposit insurance aims to prevent bank runs and maintain financial stability by giving depositors confidence that their insured deposits are safe.
Deposit insurance is required because of fractional reserve banking and maturity mismatch between short-term deposits and long-term loans. In the presentation we explain the advantages and disadvantages of fractional reserve banking.
To complement the mechanism of creation of deposits with fractional reserve banking, we present the determination of the money supply as the combination of decisions made by the public (depositors and borrowers), commercial banks and the central bank in terms of deposits, currency, required reserves and excess reserves.
To provide a worldwide view of existing deposit insurance institutions, we analyze the information in the International Association of Deposit Insurers (IADI) Annual Survey, which describes the year of establishment of the deposit insurance agencies (DIAs), their types, their legal structure, their mandates, their members, the types of deposit products eligible for coverage, if membership in the deposit insurance scheme (DIS) is mandatory, the type of funding used in the DIS, the method for assessing or levying premiums on member banks/institutions, the role of deposit insurers in resolution decision-making, the tools or methods available for dealing with failing banks, the authority to act as administrator/conservator, the authority to act as receiver/liquidator, the government of the resolution framework, and the maximum coverage limit per depositor per institution.
Finally, to review the role of financial intermediaries as providers of liquidity and insurance, we present a simple model where early liquidations of investment projects destroy value and prevent savers from reaping a return on their investment. We show that the market allocation could improve upon an autarky one, but that it is not necessarily efficient. We show that in an economy where agents individually face independent liquidity shocks, the market allocation could be improved by a deposit contract offered by a financial intermediary.