Deposit Insurance--- another important factor

In the last blog, I discussed Basel’s role in banking regulation. This week, I will introduce another important factor---Deposit insurance. Deposit insurance is a financial security system, which plays a crucial role in banking regulation. It maintains bank credit and stable financial system.

Diamond (1983) and Dybvig (1983) think that the vulnerability of banks make deposit insurance more important. The implementation of the deposit insurance system can reduce bank runs effectively. At the same time, it can protect the interests of depositors when the bank bankruptcy.

Of course, some people do not think the deposit insurance system can stable the operation of financial institutions. What’s more, they believe deposit insurance may aggravate financial risk.

Park (1992) argues that the infectious effect of financial crisis is closely related to information asymmetry. The most effective means is to provide more bank specific information. Deposit insurance system cannot solve the problem. Dowd (1993) thinks that, only under a full competition market environment, the operation of banks can be more effective. Competition makes bankers find the optimal equilibrium between protection of depositors and investment return. Deposit insurance by government can weaken the bank competition. Matutes and Vives (2000) believe that deposit insurance lead to bank increase their interest rates to attract depositor. It will amplify bank systemic risk.

However, as far as I am concerned, legal deposit insurance system can regulate bank in advance, and warned the question bank. These measures can strengthen the regulation of prior crisis. Further, it is also a relief mean when bank bankrupt, which avoid triggering systemic crisis and maintain the safety and stability of the financial system. Deposit insurance system will also give the authority of managing and supervising to the deposit insurance companies. These companies will pay more attention to the management status of bank. So, I think Deposit insurance is an important fact in banking regulation.