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I study the relation between shadow banking and financial stability in an economy in which banks are susceptible to self-fulfilling runs and in which government-backed deposit insurance is limited. Shadow banks issue only uninsured deposits while commercial banks issue both insured and uninsured deposits. The effect of shadow banking on financial stability is ambiguous and depends on the (exogenous) upper limit on insured deposits. If the upper limit on insured deposits is high, then the presence of a shadow banking sector is detrimental to financial stability; shadow banking creates systemic instability that would not be present if all deposits were held in the commercial banking sector. In contrast, if the upper limit on insured deposits is low, then the presence of a shadow banking sector is beneficial from a financial stability perspective; shadow banks absorb uninsured (and uninsurable) deposits from the commercial banking sector, thereby shielding commercial banks from runs. While runs may occur in the shadow banking sector, the situation without shadow banks and a larger amount of uninsured deposits held at commercial banks is worse.

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We develop a structural empirical model of the US banking sector. Insured depositors and run-prone uninsured depositors choose between differentiated banks. Banks compete for deposits and endogenously default. The estimated demand for uninsured deposits declines with banks' financial distress, which is not the case for insured deposits. We calibrate the supply side of the model. The calibrated model possesses multiple equilibria with bank-run features, suggesting that banks can be very fragile. We use our model to analyze proposed bank regulations. For example, our results suggest that a capital requirement below 18 percent can lead to significant instability in the banking system. (JEL E44, G01, G21, G28, G32)

In November 2015, the European Commission adopted a legislative proposal to set up a European Deposit Insurance Scheme (EDIS), a single deposit insurance system for all bank deposits in the Banking Union. JRC was requested to quantitatively assess the effectiveness of introducing a single deposit insurance scheme and to compare it with other alternative options for the set-up of such insurance at European level. JRC compared national Deposit Guarantee Schemes and EDIS based on their respective ability to cover insured deposits in the face of a banking crisis. Analyses are based upon the results of the SYMBOL model simulation of banks' failures.

During September 1-15, 2015 an assessment under the IMF/World Bank Financial Sector Assessment Program (FSAP) was conducted for Montenegro. The mission assessed financial sector risks and vulnerabilities, assessed the quality of financial sector supervision, and evaluated financial safety-net arrangements. As part of the FSAP, the deposit insurance system was assessed against the BCBS-IADI Core Principles for Effective Deposit Insurance Systems (CP) from 2009. The revised IADI CP from 2014, which still have to be adopted by the IMF and the World Bank, have been used as a reference in this assessment. The assessment was conducted by a team of experts from the World Bank and IMF. The assessment has the following main findings: The deposit insurance system in Montenegro is relatively well developed. DPF was established in 2006 and operates under the narrow mandate of a pay-box. It is financed by annual premiums from member banks, supported by a standby credit line with the EBRD and a statutory provision for back-up funding from the government. The current level of funding is sufficient to cover the insured deposits in all small banks. The coverage level is EUR 50,000 per depositor per bank and covers natural and legal persons. With this level, DPF insures 99.26 percent of depositors and 36.38 percent of deposits fully. Since its establishment, DPF has developed much of the infrastructure required to ensure prompt payout of deposits, including payout software to reimburse depositors within fifteen working days after a bank failure and a MoU to support information exchange and coordination with CBM. The deposit insurance system has never been triggered.

The Federal Deposit Insurance Corporation (FDIC) currently insures bank deposit balances up to $100,000. According to some observers, statutory protection creates moral hazard problems for insurers because it allows banks to engage in risky activities. As an example, moral hazard was a key contributor to huge losses suffered when thrift institutions failed during the 1980s. This brief by Panos Konstas outlines a plan to reduce the risk of government losses by replacing insured deposits with uninsured deposits and eliminating some of the costs of deposit insurance. His plan proposes a self-insured (SI) depositor system that places an intermediary between the lender (saver) and borrower (bank) in the credit-flow chain. The FDIC would guarantee saver loans and allow the intermediary to borrow at the risk-free interest rate if the intermediary's bank deposit is statutorily defined outside the realm of FDIC insurance. The risk is therefore transferred to depositors (intermediaries); thus creating incentives for depositors to earn a rate of return at least equal to the cost of borrowing plus a risk premium based on the risk profile of banks.

We study the consequences and optimal design of bank deposit insurance in a general equilibrium model. The model involves two production sectors. One sector is financed by issuing bonds to risk–averse households. Firms in the other sector are monitored and financed by banks. Households fundbanks through deposits and equity. Deposits are explicitly insured by a deposit insurance fund. Any remaining shortfall is implicitly guaranteed by the government. The deposit insurance fund charges banks a premium per unit of deposits whereas the government finances any necessary bail-outs by lump-sum taxation of households. When the deposit insurance premium is actuarially fair or higher than actuarially fair, two types of equilibria emerge: One type of equilibria supports the socially optimal (Arrow–Debreu) allo-cation, and the other type does not. In the latter case, bank lending is too large relative to equity and the probability that the banking system collapses is positive. Next, we show that a judicious combination of deposit insuranceand reinsurance eliminates all non–optimal equilibrium allocations.

We study the consequences and optimal design of bank deposit insurance in a general equilibrium model. The model involves two production sectors. One sector is financed by issuing bonds to risk-averse households. Firms in the other sector are monitored and financed by banks. Households fund banks through deposits and equity. Deposits are explicitly insured by a de- posit insurance fund. Any remaining shortfall is implicitly guaranteed by the government. The deposit insurance fund charges banks a premium per unit of deposits whereas the government finances any necessary bail-outs by lump-sum taxation of households. When the deposit insurance premium is actuarially fair or higher than actuarially fair, two types of equilibria emerge: One type of equilibria supports the socially optimal (Arrow-Debreu) allo- cation, and the other type does not. In the latter case, bank lending is too large relative to equity and the probability that the banking system collapses is positive. Next, we show that a judicious combination of deposit insurance and reinsurance eliminates all non-optimal equilibrium allocations.

We study the consequences and optimal design of bank deposit insurance and reinsurance in a general equilibrium setting. The model involves two production sectors, financed by bonds and bank loans, respectively. Financial intermediation by banks is required in the model as we assume that one of the production sectors is risky and requires monitoring by banks. Households fund banks through deposits and equity. Deposits are explicitly insured and banks pay a premium per unit of deposits. Any remaining shortfall is implicitly guaranteed by the government. Two types of equilibria emerge: One type of equilibria supports the Pareto optimal allocation. In the other type, bank lending and the default risk are excessively large. The intuition is as follows: the combination of financial intermediation by banks, limited liability of bank shareholders, and deposit insurance makes deposits risk-free from the individual households' perspective, although they involve risk from the societal point of view. This distorts investment choices and the resulting input allocation to production sectors. We show, however, that a judicious combination of deposit insurance and reinsurance eliminates all non-optimal equilibrium allocations. Our paper thus may provide a benchmark result for policy proposals advocating deposit insurance cum reinsurance. ; ISSN:1614-2446 ; ISSN:1614-2454