Financial Stability and FDIC Insurance

The Federal Deposit Insurance Corporation (FDIC) was created over five decades ago to increase the stability of the banking system. Questions of how and whether the FDIC enhances stability or welfare are now being raised in the economic literature. Buser et al. (1981) argue that deposit insurance has been deliberately under-priced so that the FDIC’s package deal, which includes both insurance and regulation, will be attractive to banks. These authors identify a deadweight loss associated with this particular incentive structure. Campbell and Glenn (1984) discuss the determinants of the optimal policies regarding deposit-insurance pricing and bank closings. They show that appropriate policy depends in an important way on the nature of the mechanism for determining insolvency. Chan and Mak (1984) show that, given some exogenously determined constraint on the bank-failure rate, a risk-sensitive premium for deposit insurance may be ill-advised. These authors focus their analysis on the trade-off between depositors’ welfare and the soundness of the insurance system.