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Managing Deposit Insurance Through Economic Cycles: Insights and Implications

This comprehensive analysis examines the intricacies of managing deposit insurance (DI) across economic cycles. It outlines the unique aspects of DI compared to other insurance types, explores the impact of bank failures on economic activity, and discusses resolution strategies. The study also highlights the significance of interbank contagion, the role of institutional environments, and the importance of liquidity management. By investigating how bank failures affect businesses and overall economic performance, this research provides valuable insights for regulators and financial institutions.

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Managing Deposit Insurance Through Economic Cycles: Insights and Implications

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  1. Comments Joseph R. Mason Drexel University, the Wharton School, and FDIC

  2. Managing DI Through the Cycle • DI is different from other types of insurance. • Katrina: Property insurance. • Auto: my car • DI gives claimants $, but takes assets. • Liquidates and recovers over time: time consistency problem. • How does DI reserve for losses? • First, observe that gross lossest > net lossest+m

  3. Managing DI Through the Cycle Reserve Savings t Financing

  4. Managing DI Through the Cycle

  5. Managing DI Through the Cycle • DI manages liquidation as AMC to achieve reserve savings. • monitoring, capital , liquidity • Three important questions: • What makes banks fail? • What determines resolution strategy? • What effect do failures and their resolution have on economic performance?

  6. Rajkamal Iyer and Jose L. Peydro-Alcalde, “Interbank Contagion: Evidence from Real Transactions.” • Directly models contagion via interbank exposure data among large Indian banking institutions at the time of the failure of the Madhavan Mercantile Cooperative Bank (MMCB) March 10-12, 2001 due to fraud. • Institutional Environment: Much like U.S. Credit Union system. • Data: • 3/31/01 (public) and 12/31/01 (CB) deposit data. • 3/31/01 balance sheet data. • 3/31/01 MMCB deposit exposure (source?). • 3/31/01 interbank exposure. • Findings: • 1. Exposure to MMCB (-) related to deposit growth. • 2. Test individual bank: • media coverage; • release (by bank) of exposure information regarding MMCB; • importance of government mandate in general vs. MMCB exposure in particular.

  7. Greg Caldwell, “An Analysis of Closure Policy under Alternative Regulatory Structures.” • Theoretical adaptation of Repullo (JMCB 2001) and Kahn and Santos (2001). • Examines bank choice of risk given institutional AMC design. • Looks at welfare Implications of resolving failure where: W=(u, A0, m, A, AM, f, l, AC, q, , R) • Key to theory is assumption of difference between: • benevolent supervisory agency ; • self serving deposit insurer. • General idea is that “ benevolent supervisory agency” is more likely to resolve through merger to preserve desirable social investment. • Vulture capitalist vs. AMC • LCR vs. EPOR • Merger facilitated by capital infusion (forbearance)?

  8. Reserve Savings t Financing Managing DI Through the Cycle

  9. Carlos Ramirez and Philip Shively, “Do Bank Failures Affect Real Economic Activity?” • Empirical Application: follow on CM (2003) and AKM (JMCB 2005) using state-level data to identify real effects of bank failures. • Bank Fails → Business Fails? • Business Fails → Bank Fails? • Impulse vs. Propagation • Use 48 state-level VARs. Find Bank Fails → Business Fails NOT Business Fails → Bank Fails • Then seeks to identify why Bank Fails → Business Fails. Answers: •  deposits ser capita •  loans per capita •  branching dummy •  DI dummy

  10. Reserve Savings t Financing Managing DI Through the Cycle • What makes banks fail? • What determines resolution strategy? • What effect do failures and their resolution have on economic performance?

  11. Managing DI Through the Cycle

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