Deposit Insurance: An Outmoded Lifeboat for Today's Sea of Liquidity?
50 Pages Posted: 5 Jan 2002
Date Written: March 1, 2001
Recent changes in financial markets have altered the structure of liquidity provision and thus undercut the relative importance of the banking sector. Our analysis suggests a significant contraction of banks' role as liquidity transformers and hence a reduction in their susceptibility to the specific risks of liquidity transformation, including systemic runs due to contagious spillovers. This contraction is confirmed by an analysis of liquidity at the individual bank level using a liquidity measure that we develop. We use this measure to quantify the marginal contribution of deposit insurance to liquidity enhancement. We conclude that neither insurance against liquidity risk, nor other rationales relating to equity, legitimacy and stability withstands closer scrutiny as a valid explanation for the provision of deposit insurance by the government.
JEL Classification: G21, G28
Suggested Citation: Suggested Citation