The Promise and Peril of Comprehensive Deposit Insurance

With Germany and Ireland now having more or less made explicit 100% guarantees for all deposits, many people are wondering who’s next in the face of the current credit crisis. Will it be the U.S., which only has about 64% of deposits insured, even at the new $250,000 limits? (Note that some of this is high net-worth sorts, but much of it is interbank lines between foreign institutions and U.S. banks. In other words, if it decided to move, much of it could move in a hurry, neatly making the U.S. banks insolvent.)

My friend Nouriel Roubini argues that the U.S. needs to temporarily extend deposit insurance to all money on deposit with U.S. banks, thus negating the likelihood of a so-called silent bank run. Others point out that Japan tried precisely this during its banking crisis, and it had no impact — the bank runs happened anyway as uninsured deposits from foreign counterparties scooted. I’m torn on this one, and I understand the argument, but without the some commitment to triage — picking winners and losers among the banks — this could quickly become a mess. And I am just not convinced that the FDIC and Treasury have reached the point where it wants to make that part of the eventual nationalization explicit yet. The latter will happen, and ‘t were better it happened sooner than later, but Paulson/Bernanke still seem to be fighting from the rear on this.

More reading here:

Deposit Insurance and Crisis Management

Gillian Garcia
GGH Garcia Associates

March 2000

IMF Working Paper No. 00/57

Abstract:    
A well-designed deposit insurance system (DIS) will provide incentives for citizens to keep the financial system sound. However, a poorly designed DIS can foster a financial crisis. This paper, therefore, makes recommendations for creating and running a limited, incentive-compatible, DIS. The paper also examines factors in the decision to grant, temporarily, a comprehensive guarantee, and the design of that guarantee, should a systemic financial crisis nevertheless occur. It concludes with guidance on the removal of that guarantee.

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