Deposit Insurance | SRJ LATEST NEWS

The 2022 Nobel Prize in Economic Sciences to a trio of economists who studied the role of banks in financial crises, deposit insurance and banking regulation—two areas of finance that sometimes slip under the radar—are experiencing a moment in the spotlight.

Professor Philip Dybvig of Washington University in St. Louis was one of the three winners. In 1983, he and fellow awardee Douglas Diamond co-wrote the highly regarded article "Bank Runs, Deposit Insurance, and Liquidity," which essentially rewrote the economic literature on the causes and mitigation of bank runs. The paper's identification of the underlying tensions between savers and borrowers during times of economic crisis may be its most significant finding.

According to Dybvig,

 "We focus on the rational side [of bank panics], and you can learn a lot by viewing the people as reasonable," said David Brancaccio, host of "Marketplace Morning Report." It makes sense for you to withdraw your money if you anticipate that others will do the same.

The conversation between them is summarised here.Using David Brancaccio I like to think that you, professor, have created some sort of shrine to the Federal Deposit Insurance Corporation somewhere in your house. You must be a supporter of the FDIC given your research on bank runs.

Dybvig: 

I believe I've seen "Double D" written down, but I hear "DD" more frequently than "Double D." So, to be completely honest, I have no idea how people pronounce it. Similar to how names are pronounced, you don't know until someone informs you.

Brancaccio:

 We'll name it DD then. But here's the thing: The Federal Deposit Insurance Corporation was created in part as a response to events that occurred at the turn of the century. Your essay is from the 1980s, not now. Despite the fact that we already had federal deposit insurance, what was it about your document that made it so crucial?

Dybvig: 

As a result, I'm not entirely clear of the past. However, I believe that deposit insurance was primarily implemented for consumer protection rather than for stability. And what makes our article unique is that it asserts that it is not necessarily denying that bank panics have psychological components. However, we emphasise the rational components since this helps us understand people better. Therefore, it is not as if everyone suddenly becomes hysterical and rushes to the bank to withdraw their money. Instead, it is sensible for you to withdraw your money as well if you believe that others will do the same.

Brancaccio: 

You notice that occasionally when a bank run is about to happen in one nation or another, policymakers just tell the populace to stay calm and not withdraw their money because that would be in the greater good. And it could be the case. However, in terms of the person, if there is a chance of losing it, you sort of want to be early rather than last.

Dybvig:

 That is accurate. That is entirely accurate. And it makes sense to do that. Currently, it is true that different equilibria exist. And you might convince them to change to a more favourable balance. However, that is plainly less effective than a strategy like deposit insurance, which simply eliminates the initial equilibrium.

Brancaccio:

 You may have noticed that when a bank run is occasionally building in one nation or another, policymakers simply advise the populace to remain calm and refrain from withdrawing money because doing so would be against the interests of the larger community. That might be the case. However, if there is a chance that you could lose it personally, you kind of want to be first rather than last.

Dybvig:

 You're correct. Absolutely correct. It makes sense that way. Currently, it is true that there exist several equilibria. As well as convincing individuals to migrate to a more favourable balance. But it is evident that this is less effective than a policy like deposit insurance, which merely eliminates the original equilibrium.

Brancaccio:

 Where do you stand, professor, on the economics concept of "moral hazard," which states that riskier activity might be encouraged if one is aware of some form of insurance or assurance that they would be saved if something goes wrong. Do we simply have to deal with moral hazard, or do you see it as a delicate balance?

Dybvig:

 That is therefore a crucial aspect of bank regulation. Bank inspectors supervise our banking operations. In reality, it performs the same function as loan covenants in private lending. Therefore, having a Deposit Insurance Fund means that the Deposit Insurance Fund will take on the downside risk that may otherwise be assumed by the bondholders and depositors. Furthermore, it's crucial to.

Brancaccio:

 Recently, we published a study on a survey of CEOs, finding that more than 90% of them predicted a US recession for the coming year—and that two-thirds of them believed it would be far worse. Are there any lessons you could impart from your work on what policymakers should or shouldn't do if things grow tougher and businesses and other institutions start to sputter?

Dybvig:

 For myself, I consider the present circumstances. Of course, out of possible vanity, I would like to map every circumstance into our setting, but things are subject to change. I do not, however, currently view a financial catastrophe as being a part of that. I see typical large inflation, possibly stagflation, brought on by large deficits and large spending. And I don't necessarily anticipate a collapse of the financial system. But at this time, it appears that the macroeconomic side of the question should be addressed.\

Brancaccio:

 I get you when you say that, given the macroeconomic issues we've been discussing, inflation, and higher interest rates in a potential recession, you don't see the makings of a financial crisis. But there could be a financial crisis caused by something very unforeseeable between now and the time you and I retire. Is there any overarching advice you have for policymakers that would be relevant the next time we need to consider a financial crisis and how to respond to one?