Deposit Insurance And Moral Hazard

In world, almost all countries actually have financial safety nets in place which include deposit insurance, bank regulation and supervision, central bank lender of last resort facilities. Since the first deposit insurance scheme was established in U.S in 1934, more and more governments have introduced the scheme. Deposit insurance has become an increasingly used tool by governments in an effort to ensure the stability of banking systems and protect bank depositors from incurring large losses due to bank failures. But , the wide acceptance of the need for a deposit guarantee scheme does not, however, reflect abelief that the moral hazard implications of such schemes are negligible and can be ignored. The moral hazard in deposit insurance weakens its positive effects in the stability of banking systems. At present, the Chinase government is preparing to introduce the scheme. If we don't have tangible ways to control the moral hazard, it will have negative infulence in the stability of banking systems. Therefore, if we find the ways before the establishment, we will get the important realistic meaning and practice value.This paper uses game theory to analyse the cause of the moral hazard in deposit insurance. As we know, deposit insurance protects bank depositors from incurring large losses due to bank failures, and has positive effects in stability of banking systems. But, due to the information asymmetry, deposit insurance induces the depositors' moral hazard, banks' moral hazard, financial supervisal organizations' moral hazard. These moral hazards bring bad influence to macro economy. What shall we do to control the moral hazards? This paper combines case analysis, using U.S and Germany as examples. Drawing lessons from two deposit insurance models, we find that there are two important steps to do. First of all, premiums may vary according to the riskiness of the assessment base which are then called risk-adjusted premiums. Second, deposit insurance design is also very important. We do studies as the steps. First ,we apply the put-option model of Ronn&Verma (1986) to calculate the deposit insurance premium of listed commercial banks in China. Then we apply new Market-Oriented Deposit Insurance Scheme(MODIS) to validate the former results. In conclusion, we make suggestions of the deposit insurance design, including coverage limits, amount of coverage, extent of coverage, funding source, administration and membership,etc.There are three innovations in this paper. First, this paper uses game theory to analyse the cause of the moral hazards in deposit insurance. We draw the conclusion that it just because of the protection of the insurance system, stabilized and helped function to produce correspondly the depositors' moral hazard, banks' moral hazard, financial supervisal organizations' moral hazard. Second, we apply the put-option model of Ronn&Verma (1986) to calculate the deposit insurance premium of listed commercial banks in China in 2005. Third, we apply new Market-Oriented Deposit Insurance Scheme(MODIS) for the first time.