The Economics of Network-Based Deposit Insurance

Abstract

We examine the financial stability implications of deposit insurance using reciprocal deposits, a financial innovation through which banks can break up large deposits and place them with others in an offsetting manner. We show that higher insurance coverage allowed banks to stem deposit outflows during the 2023 banking crisis. Network banks paid lower deposit rates, grew larger, and expanded their local deposit market share, while assuming greater exposure to interest rate risk. We discuss the trade-offs of deposit insurance and its impact on the banking sector's industrial organization.

Keywords: Deposit Insurance, Reciprocal Deposits, Financial Stability, Bank Risk, Moral Hazard, Public Deposits

JEL Classification: G21, G28