Deposit Insurance System: Model Specification, International Comparison and China Research

Deposit Insurance System:

Model Specification, International Comparison and China Research

Deposit insurance system is a fundamental system of financial security network which aims to maintain depositors’ confidence and avoid bank run.

Till now, a large number of academic papers have covered this issue, giving us a picture of deposit insurance system model specification.

So far, deposit insurance system has a history of over 70 years since its first establishment in 1930’s. According to International Association of Deposit Insurers (IADI), as of 31 March 2011, 111 countries have already implemented explicit deposit insurance, which, helps us to compare with an international vision.

China now has considering the establishment of explicit deposit insurance. How to implement effectively is a most concern in today’s study.

Ⅰ Model Specification

Deposit insurance system is instituted to guarantee the safety of both credit application and deposits to avoid panic bank run. However, with adoption of deposit insurance system, moral hazard problem may implement, as President Franklin Delano Roosevelt once said, this system” would put a premium on unsound banking.”

Under deposit insurance, banks have incentives to take more risk as insured depositors now will not require a risk premium in certain that they will get their deposits legally. In this case, banks may make riskier investment or increase leverage, making insurer ore chances of loss.

Here a simple model is built to explain the cause of the moral hazard implement.

Assumptions:

(1) The market risk-free rate and the deposit rate are both 0.

(2) There exist 2 periods, t0 and t1. In period t0, banks get deposits and pay deposit insurance premium. In period t1, the bank accounts are clear and depositors get payment no matter whether the bank has enough assets.

(3)