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Banking and deposit insurance as a risk-transfer mechanism

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  • Sangkyun Park

Abstract

This paper models an economy in which risk-averse savers and risk-neutral entrepreneurs make investment decisions. Aggregate investment in high-yielding risky projects is maximized when risk-neutral agents bear all nondiversifiable risks. A role of banks is to assume nondiversifiable risks by pledging their capital in addition to diversifying risks. Banks, however, do not completely eliminate risks when monitoring by depositors is not perfect. Government deposit insurance that uses tax revenue to pay off depositors effectively remaining risks to entrepreneurs. Deposit insurance improves welfare because imperfect monitoring by the government results in income transfer among risk-neutral agents rather than lower production.

Suggested Citation

  • Sangkyun Park, 1994. "Banking and deposit insurance as a risk-transfer mechanism," Working Papers 1994-025, Federal Reserve Bank of St. Louis.
    • Handle: RePEc:fip:fedlwp:1994-025
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    References listed on IDEAS

    as
    1. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 24(Win), pages 14-23.
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    Keywords

    Deposit insurance;

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