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Endnotes1 The point that reform should logically precede
further deregulation was forcefully made as early as 1983 by Kareken. 2 This essay deals with bank regulation in general,
and the Federal Deposit Insurance Corporation (FDIC) in particular.
But, most of our policy recommendations would be equally applicable
to the savings and loan industry and their insurer, the FSLIC.
What is not discussed here is the current financial crisis of
the FSLIC, a problem which is (thankfully) unique to that institution.
3 Data for uninsured deposits in failed banks that were purchased by other banks are not available. We estimate uninsured deposits as the difference between total assets and total insured deposits, based on the assumption that equity of failed banks is zero.
4 The moral hazard problem is, in fact, more extreme with deposit insurance than it is with many forms of private insurance. The FDIC does not prohibit troubled banks from buying more insurance (that is, acquiring more deposits). This is analogous to allowing the owners of a factory to buy more fire insurance when their factory is on fire.
5 While bank stock owners may be able to effectively diversify their risks, this is much more difficult for the senior management of banks. That is so because when a bank fails it may reflect on their skill as managers, and thus on the value of their human capital. This point is sometimes raised as an important force countervailing the incentive effects of moral hazard. However, if bank owners genuinely want managers to pursue high-risk
strategies, it seems they can get their wish. One obvious way is to pay
managers sufficiently high current salaries to offset their risk of loss
should bankruptcy occur in the future.
6 The high potential earnings in commercial banking were undoubtedly dissipated, in part, by subsidizing loan rates and by non-price competition for depositors. But the monotonously low failure rate through the 1970s strongly supports the notion that bank owners were still doing well.
7 The protective subsidy notion is more fully discussed and defended in Benveniste, Boyd and Greenbaum (1988).
8 Continuing this trend, on January 18, 1989, the Board of Governors ruled that five major banking firms could underwrite and deal in corporate debt. The Board also indicated at that time that (if all went well with debt underwriting) it would consider permitting banking concerns to underwrite corporate equities within about a year. In a previous decision (April 30,
1987), the Board approved applications to underwrite commercial paper, mortgage-backed securities, municipal revenue bonds and consumer related
receivables. Even earlier, discount brokerage was determined to be a
permissible activity for banking organizations on January 7, 1983.
9 100 percent reserve banking was proposed by Simons (1936) and later by Friedman (1959).
10 In theory, at least, the incentive effects of closing banks before they fail are much like those of the protective subsidy.
11 We are not suggesting that banks should be kept open when all available information indicates that the value of their liabilities exceeds the value of their assets. This policy invites end-gaming strategies on the part of bankrupt institutions, and is in large part to blame for the recent losses of the FSLIC.
12 In 1988, new capital guidelines were announced for banks in the United States and a number of other countries, pursuant to an international agreement in Basle, Switzerland. The Basle Agreement calls for minimum capital of 7.25 percent of assets by the end of 1990 and 8 percent of assets by the end of 1992. The new capital requirements are risk-progressive, at least in terms of asset risk. Five risk classes are established for assets and off-balance sheet items. Each is weighted from 0 to 1.0 with cash and short-term U.S. Treasury bills receiving the lowest weight, whereas most bank loans receive
the highest weight. All other assets are assigned weights of 0.1, 0.2, or
0.5, depending on their assessed risk. For a detailed discussion of the Basle
Agreement risk classifications, see Federal Reserve System (1988).
13 We claim no originality for this proposal. In fact, it has some historical precedent. Co-insurance was part of the original deposit insurance plan that was to go into effect on July 1, 1934 (FDIC, p. 44). Deposits up to $10,000 for each depositor were to be fully insured. Over $10,000 but under $50,000 was to have 75 percent coverage, and over $50,000 only 50 percent coverage. This plan, however, was superseded by a new plan that was part of
the Banking Act of 1935 which provided only full coverage up to $5,000.
14 The seminal work on time inconsistency is Kydland and Prescott (1977). For a less technical discussion of this problem, see Chari (1988). |
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Glossary More about Deposit Insurance Reform |
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Annual Report
