Deposit Insurance in General Equilibrium

CER-ETH – Center of Economic Research at ETH Zurich, Working Paper no 16/258, 2016

50 Pages Posted: 14 Sep 2016

See all articles by Volker Britz

Volker Britz

Maastricht University - Department of Economics

Hans H. Haller

Virginia Polytechnic Institute & State University - Department of Economics

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Reseaarch; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Date Written: September 13, 2016

Abstract

We study the consequences and optimal design of bank deposit insurance in a general equilibrium model. The model involves two production sectors. One sector is financed by issuing bonds to risk-averse households. Firms in the other sector are monitored and financed by banks. Households fund banks through deposits and equity. Deposits are explicitly insured by a deposit insurance fund. Any remaining shortfall is implicitly guaranteed by the government. The deposit insurance fund charges banks a premium per unit of deposits whereas the government finances any necessary bail-outs by lump-sum taxation of households. When the deposit insurance premium is actuarially fair or higher than actuarially fair, two types of equilibria emerge: One type of equilibria supports the socially optimal (Arrow-Debreu) allocation, and the other type does not. In the latter case, bank lending is too large relative to equity and the probability that the banking system collapses is positive. Next, we show that a judicious combination of deposit insurance and reinsurance eliminates all non-optimal equilibrium allocations.

Keywords: Financial intermediation, deposit insurance, capital structure, general equilibrium, reinsurance

JEL Classification: D53, E44, G2

Suggested Citation

Britz, Volker and Haller, Hans H. and Gersbach, Hans, Deposit Insurance in General Equilibrium (September 13, 2016). CER-ETH – Center of Economic Research at ETH Zurich, Working Paper no 16/258, 2016. Available at SSRN: https://ssrn.com/abstract=2838225 or http://dx.doi.org/10.2139/ssrn.2838225

Volker Britz (Contact Author)

Maastricht University - Department of Economics ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands

Hans H. Haller

Virginia Polytechnic Institute & State University - Department of Economics ( email )

3021 Pamplin Hall
Blacksburg, VA 24061
United States
540-231-7591 (Phone)
540-231-5097 (Fax)

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Reseaarch ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland
+41 44 632 82 80 (Phone)
+41 44 632 18 30 (Fax)

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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