Dualism of Government Guarantees: Evidence from the 2005 FDI Reform Act

Abstract

I present a novel approach to the study of the trade-off between stability and moral hazard induced by deposit insurance. Specifically, I use the FDI Reform Act of 2005 as an exogenous shock to the existing insurance scheme in the US and study its impact on bank risk. This reform raised the coverage limit for individual retirement accounts (IRAs) from USD 100,000 to 250,000. I report an increase in banks’ liquidity and insolvency risk caused by this Reform. In addition, I show banks more influenced by the 2005 reform were 38 percentage points less likely to fail during the GFC.

Keywords: deposit insurance, moral hazard, liquidity risk, insolvency risk, banking crises

JEL Classification: G01, G20, G21, G28, E44