The Cost of Deposit Insurance for Privately Held Banks: A Market Comparable Approach

Posted: 17 Feb 2004

See all articles by George Pennacchi

George Pennacchi

University of Illinois

Michael Falkenheim

Office of Management and Budget (OMB)

Abstract

Previous empirical studies that use an option pricing model to estimate deposit insurance costs have been limited to banks that issue publicly traded securities: a bank's security prices are used to infer its risk characteristics. However, if deposit insurance costs are needed for privately held banks, as would be the case under a system of risk-based insurance premiums, then an alternative method is required. This paper presents a "market comparable" approach for valuing private banks' deposit insurance. The approach first uses information on public depository institutions to identify the statistical relationships between a bank's supervisory accounting data and its risk characteristics derived from equity market data. Second, it uses these relationships to predict the risk characteristics of a private depository institution based on its supervisory accounting data. This approach is applied to over 7000 private banks and thrifts to estimate their risk characteristics and their implied risk-neutral and physical probabilities of insolvency. For the vast majority of institutions, these risk characteristics and insolvency probabilities are within a reasonable range.

Keywords: Deposit insurance, market comparable valuation

Suggested Citation

Pennacchi, George G. and Falkenheim, Michael, The Cost of Deposit Insurance for Privately Held Banks: A Market Comparable Approach. Available at SSRN: https://ssrn.com/abstract=502585

George G. Pennacchi (Contact Author)

University of Illinois ( email )

4041 BIF, Box 25
515 East Gregory Drive
Champaign, IL 61820
United States
217-244-0952 (Phone)

HOME PAGE: http://www.business.illinois.edu/gpennacc/

Michael Falkenheim

Office of Management and Budget (OMB) ( email )

Washington, DC 20503
United States

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