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Deposit insurance and bank regulation in a monetary economy: a general equilibrium exposition

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  • John Boyd
  • Chun Chang
  • Bruce Smith

Abstract

It is commonly argued that poorly designed banking system safety nets are largely to blame for the frequency and severity of modern banking crises. For example, “underpriced” deposit insurance and/or low reserve requirements are often viewed as factors that encourage risk-taking by banks. In this paper, we study the effects of three policy variables: deposit insurance premia, reserve requirements and the way in which the costs of bank bailouts are financed. We show that when deposit insurance premia are low, the monetization of bank bailout costs may not be more inflationary than financing these costs out of general revenue. This is because, while monetizing the costs increases the inflation tax rate, higher levels of general taxation reduce savings, deposits, bank reserves, and the inflation tax base. Increasing the inflation tax rate obviously raises inflation, but so does an erosion of the inflation tax base. We also find that low deposit insurance premia or low reserve requirements may not be associated with a high rate of bank failure. Copyright Springer-Verlag Berlin/Heidelberg 2004

Suggested Citation

  • John Boyd & Chun Chang & Bruce Smith, 2004. "Deposit insurance and bank regulation in a monetary economy: a general equilibrium exposition," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 24(4), pages 741-767, November.
    • Handle: RePEc:spr:joecth:v:24:y:2004:i:4:p:741-767
    DOI: 10.1007/s00199-003-0372-5
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    Cited by:

    1. Jonathan Carroll & Shino Takayama, 2014. "A hierarchical agency model of deposit insurance," Annals of Finance, Springer, vol. 10(2), pages 267-290, May.
    2. Gersbach, Hans & Haller, Hans & Volker, Britz, 2017. "Deposit Insurance and Reinsurance: A General Equilibrium Perspective," CEPR Discussion Papers 11947, C.E.P.R. Discussion Papers.
    3. Volker Britz & Hans Gersbach & Hans Haller, 2021. "Deposit insurance and reinsurance," Annals of Finance, Springer, vol. 17(4), pages 425-470, December.
    4. Skeie, David R., 2008. "Banking with nominal deposits and inside money," Journal of Financial Intermediation, Elsevier, vol. 17(4), pages 562-584, October.
    5. Antoine Martin, 2006. "Liquidity provision vs. deposit insurance: preventing bank panics without moral hazard," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 28(1), pages 197-211, May.
    6. Kai Ding & Enoch Hill & David Perez-Reyna, 2021. "Optimal capital requirements with noisy signals on banking risk," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 71(4), pages 1649-1687, June.
    7. Ms. Elena Loukoianova & Mr. Gianni De Nicolo & John H. Boyd, 2009. "Banking Crises and Crisis Dating: Theory and Evidence," IMF Working Papers 2009/141, International Monetary Fund.
    8. cho, hyejin, 2014. "bank capital regulation model," MPRA Paper 54409, University Library of Munich, Germany.
    9. Boyd, John H. & De Nicolò, Gianni & Rodionova, Tatiana, 2019. "Banking crises and crisis dating: Disentangling shocks and policy responses," Journal of Financial Stability, Elsevier, vol. 41(C), pages 45-54.

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