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Do We Need Deposit Insurance for Large Banks?

Asli Demirgüç-Kunt's picture

I don’t think so. You may think this is an odd statement since nearly every country around the world has been busy either introducing or at least expanding its insurance coverage since the 2008 financial crisis. This is not surprising, considering that the U.S. was also in the midst of a banking crisis in 1933 when it first introduced deposit insurance.

But think of it this way. Deposit insurance is not meant to stop systemic crises; as we all know by now, governments do that. The purpose of deposit insurance is to protect individual banks from bank runs, mostly during normal times. Since large banks already have implicit protection because they are perceived to be “too-big-to-fail,” deposit insurance is really there to keep small banks in business. To the extent we believe small banks have an important role to play in supporting small, local businesses, this may be a worthy goal. But why do we still have deposit insurance for large banks?

Today I think most people agree one of the greatest challenges facing regulators of financial institutions is to figure out how to deal with the too-big-to-fail problem. It is not difficult to see that bankers will be eager to take on excessive risks if they know they’ll receive the up-side of these gambles, while taxpayers will have to pay for the down-side. This “moral hazard” is not only a problem during crises—even during normal times large banks benefit by attracting funding at much lower cost, since the perception is that they cannot fail. This distorts their risk-taking incentives, makes regulation less likely to be effective, and increases the fragility of the financial system in the long run.

Indeed, one of the often cited justifications for establishing an explicit deposit insurance system is that providing limited deposit insurance is likely to cap the government’s future commitments to depositors of insolvent institutions, rather than leaving an open-ended implicit possibility that the government might decide to bail out all depositors. However, some of my earlier work in this area shows that there is no evidence that explicit systems truly “cap” implicit guarantees and reduce moral hazard. To the contrary, if anything, having an explicit insurance system is likely to be destabilizing due to moral hazard, particularly if strong regulation and supervision fails to keep it under check. And one of the important lessons of the last crisis is that it is difficult for regulators to keep such institutions and risk-taking under control, no matter how sophisticated the supervisors may be.

Clearly deposit insurance was not much help in preventing the last crisis or capping the guarantees. So, as attention turns to ways of clawing back implicit guarantees and removing the “too-big-to-fail” subsidies, why is there still explicit insurance for these banks? For banks that are perceived to be too-large-to-fail, you may think eliminating explicit deposit insurance may not really matter. But from the viewpoint of the depositor, the choice would be to deposit in a smaller, fully insured bank versus depositing in a systemically large (and implicitly insured) bank. Coupled with some of the other measures that are under discussion to eliminate the too-big-to-fail effect (such as shelf bankruptcies) and make it too costly to be big (through additional capital costs and the like), removing explicit insurance coverage may be one additional measure to prevent banks from becoming so large in the first place.


Demirguc-Kunt, Asli, Ed Kane and Luc Laeven. Deposit Insurance around the World: Issues of Design and Implementation, Cambridge, MA: MIT Press, 2008.

Demirguc-Kunt, Asli, and Harry Huizinga. “Market Discipline and Deposit InsuranceJournal of Monetary Economics, Vol. 51(2), March 2004.

Demirguc-Kunt, Asli, and Enrica Detragiache. “Does Deposit Insurance Increase Banking System Stability? An Empirical InvestigationJournal of Monetary Economics, Vol. 49(7), October 2002.

Demirguc-Kunt, Asli and Ed Kane. “Deposit Insurance Around the Globe: Where Does it Work?Journal of Economic Perspectives, Vol. 16 (2), Spring 2002.


Asli, The point about deposit insurance and too-big-to-fail being redundant from a policy perspective is a good one. If the bank is not allowed to fail, the deposits will be safer! From a depositor point of view, these are not redundant. The guarantee provides a certainty as to who we have recourse to and for how much. The TBTF route is much more uncertain - does the bank really qualify as TBTF? Will we take a haircut on the deposits even if they are bailed out? During '08, the deposit protection helped us effectively take the bank specific uncertainty "off the table". Had that not occurred, we likely would have pulled funds from the banks that most needed them and put them in banks that needed them least.

Submitted by Anonymous on
as a depositor, no matter where I am banking small or big bank, I need the protection.

Submitted by Marius on
Asli, interesting and thoughtful idea. Another way to look at it perhaps is that if the TBTF/large/systemic banks are removed from deposit insurance (DI), they will keep collecting deposits anyway, but will not be contributing to DI funds - which may not be a palatable policy proposition in any society. Implicit guarantees for the TBTF banks will keep them growing, and removing them from DI will be unlikely to contribute to preventing them from getting large, and larger. In fact, because of the implicit guarantee, their exemption from DI would likely be interpreted as a favor to them, not a leash or stick. All that leads to a view that the TBTF banks should pay higher premiums than the smaller banks to compensate somewhat for the implicit guarantee, with the premium size dependant on (directly positively correlated with) a bank's share of total insured deposits.

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