Deposit Insurance Premiums and Bank Risk-Taking

Funding Deposit Insurance

“…Second, we characterize the welfare implications of risk-adjusted deposit insurance premiums and their effect on moral hazard, augmenting previous studies such as Pennancchi (1999), Pennacchi (2006), Acharya et al (2010), and Kim and Rezende (2020). Pennacchi (2006) argues that while government deposit insurance improves liquidity during times of financial distress, actuarially fair insurance premiums -premiums that equal the expected cost to the deposit insurance providercould, if assessed to insure systemic risks instead of idiosyncratic risks, create moral hazard and lead to longer-run economic instability.…”

“…They find that premiums should account for systemic risk caused by correlation among banks' returns, size, and interconnection. Kim and Rezende (2020) take an empirical approach and examine the effect of deposit insurance premiums on banks' demand for reserves and on interbank lending in the federal funds market. They find that premiums reduce demand for reserves and increase banks' supply of federal funds, indicating that balance sheet costs can induce banks to reach for yield.…”

Insurance Pricing, Distortions, and Moral Hazard: Quasi-Experimental Evidence from Deposit Insurance

“…However, like the current article, this literature identifies some distortions that could result from differential pricing. Kim and Rezende (2020) use a kink in the pricing of deposit insurance and estimate that higher premiums incentivize banks to search for yield by reducing their reserves and increasing their lending in the interbank market instead. Their findings are consistent with the present article's results on increased risk-taking 7 See, for instance, Gómez-Fernández-Aguado, Partal-Ureña, and Trujillo-Ponce (2014).…”