Japan's Experience with Deposit Insurance and Failing Banks: Implications for Financial Regulatory Design?

Abstract

This paper examines three decades of Japanese experience with deposit insurance and failing banks, and analyzes the implications of that experience for bank safety net reform in other countries. To date, the literature and policy debate on deposit insurance have been heavily colored by U.S. banking history and focus almost exclusively on explicit deposit protection schemes. Analysis of Japan's safety net experience suggests that (a) deposit insurance, for all its flaws, is superior to the real-world alternative -- implicit government protection of depositors and discretionary regulatory intervention in bank distress, (b) a well designed explicit deposit insurance system which includes a credible bank closure policy is the starting point for the design of effective private alternatives to a government-run safety net, and (c) the trend toward greater institutionalization of the Japanese safety net -- culminating in recent legislation to address the financial crisis -- reflects increased political competition and greater emphasis on legal as opposed to reputational systems of economic ordering in that country.

JEL Classification: G21, K23, N25, N45