Tuesday, 16 July 2013

Patrick Barron on Deposit Insurance

"Many programs call themselves "insurance" that are no such thing.  Deposit insurance is one of them.  One of the cardinal rules of any true insurance plan is that the insured has no control over what triggers benefits.  Think tornado insurance, for example.  But banks have tremendous control over what will trigger deposit insurance benefits.  First of all, it is not the deposits that one is insuring but the loans and securities.  When these default or lose value the bank cannot meet its deposit obligations.  Deposit insurance rewards banks for taking more risk in the hope of higher returns.  If it works out, the banks make lots of money.  If it doesn't, deposit insurance relieves them of their liabilities.  This is a classic case of "moral hazard", whereby the economic agent assumes more risk when all or part of his losses will be born by others."
Read the full article here

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