Credit Risk and the Deposit Insurance Premium, a Note
Posted: 31 Dec 2000
Previous research on market-based evaluation of deposit insurance premia has modeled the bank as a corporate firm with risky assets and insured liabilities. No attempt was made to analyze explicitly the risk characteristics of bank assets. The purpose of this note is to model bank lending explicitly and calculate loan-risk sensitive insurance premia. The lending function of banks creates the need to model equity as a 'capped' call option. A simulation exercise shows that market-based estimates of deposit insurance premium which ignore the cap lead to significant underestimation.
Keywords: Banking, banking regulation, deposit insurance
JEL Classification: G21, G28
Suggested Citation: Suggested Citation