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Discussion Paper

No. 2009-16 | February 11, 2009
Challenges Associated with the Expansion of Deposit Insurance Coverage during Fall 2008

Abstract

Government provision of a financial safety net for financial institutions has been a key element of the policy response to the current crisis, with governments extending existing guarantees and introducing new ones. These measures have been helpful in avoiding a further accelerated loss of confidence. But they are not costless. Like any guarantee, deposit insurance gives rise to moral hazard, especially if the coverage is unlimited. Clearly, in the midst of a crisis, one should not be overly concerned with moral hazard, as the immediate task is to restore confidence, and guarantees can be helpful in that respect. Nonetheless, to keep market discipline operational, it is important to specify when the extra insurance will end, and this timeline needs to be credible. To be able to establish such a timeline the root causes of the lack of confidence – that is the effects of troubled assets on financial firms’ health – need to be addressed effectively. On a more fundamental level, once a government has ventured down the road of guarantee expansion, there may be a general perception that a government guarantee will always be available during crisis situations. As a consequence, other elements of the financial safety net may need to be strengthened, including the prudential and supervisory framework.


Paper submitted to the special issue “Learning from the Financial Crisis

JEL Classification

E61 G22

Cite As

Sebastian Schich (2009). Challenges Associated with the Expansion of Deposit Insurance Coverage during Fall 2008. Economics Discussion Papers, No 2009-16, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2009-16

Assessment



Comments and Questions


Anonymous - Referee Report
March 30, 2009 - 10:06

see attached file


Sebastian Schich - Reply to Referee Report
April 22, 2009 - 14:30

see attached file


Walker F.Todd - Is this Risk Insurable? A Response to Sebastian Schich
April 07, 2009 - 11:33

see attached file


Francis Ahking - Comments
April 10, 2009 - 18:54

See pdf file


William Gavin - Associate Editor Decision
April 27, 2009 - 15:30

see attached file