Working Paper: NBER ID: w22692
Authors: Charles W. Calomiris; Matthew S. Jaremski
Abstract: Deposit insurance reduces liquidity risk but it also can increase insolvency risk by encouraging reckless behavior. A handful of U.S. states installed deposit insurance laws before the creation of the FDIC in 1933, and those laws only applied to some depository institutions within those states. These experiments present a unique testing ground for investigating the effect of deposit insurance. We show that deposit insurance increased risk by removing market discipline that had been constraining erstwhile uninsured banks. Taking advantages of the rising world agricultural prices during World War I, insured banks increased their insolvency risk, and competed aggressively for the deposits of uninsured banks operating nearby. When prices fell after the War, the insured systems collapsed and suffered especially high losses.
Keywords: No keywords provided
JEL Codes: G21; G28; N22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increase in Risk-Taking Behavior among Insured Banks (G28) | Higher Loan-to-Asset Ratios (G32) |
| Increase in Risk-Taking Behavior among Insured Banks (G28) | Lower Cash Reserves at Insured Banks (G21) |
| Insured Banks (G28) | Attract Deposits Away from Uninsured Banks (G28) |
| Attract Deposits Away from Uninsured Banks (G28) | Significant Increase in Deposit Share (G21) |
| Deposit Insurance (G28) | Higher Insolvency Risk for Insured Banks (G33) |
| Agricultural Price Boom (Q11) | Expansion of Loan Portfolios by Insured Banks (G21) |
| Fall in Agricultural Prices (Q11) | Significant Losses for Insured Banks (G28) |
| Deposit Insurance (G28) | Overall Instability of Banking System (F65) |
| Deposit Insurance (G28) | Increase in Risk-Taking Behavior among Insured Banks (G28) |