Paper #175

Title:

Optimal regulation of a fully insured deposit banking system

Authors:

Xavier Freixas and Emmanuelle Gabillon

Date:

May 1996

Abstract:

We analyze risk sensitive incentive compatible deposit insurance in the presence of private information when the market value of deposit insurance can be determined using Merton's (1997) formula. We show that, under the assumption that transferring funds from taxpayers to financial institutions has a social cost, the optimal regulation combines different levels of capital requirements combined with decreasing premia on deposit insurance. On the other hand, it is never efficient to require the banks to hold riskless assets, so that narrow banking is not efficient. Finally, chartering banks is necessary in order to decrease the cost of asymmetric information.

Keywords:

Regulation,mechanism design,deposit insurance pricing,capital requirements

JEL codes:

G13, G21

Area of Research:

Finance and Accounting

Published in:

Journal of Regulatory Economics, 16, 2, (1999), pp. 111-134

Download the paper in PDF format