ECON1102
无忧班 SA2

Tutor: Billy
Date：2021-7-25


I. Structure:
Explain the reasons why other countries have introduced deposit insurance. Outline at least one
benefit and one cost of deposit insurance.
0. Background
Banks have fragile business models because they borrow short (through deposits which are
repayable on demand) and lend long (through mortgages and other loans that are repayable at
a fixed date in the future).
Banks do not hold sufficient funds to repay all, or even most, of their depositors at once.
Bank regulation provides some protection because banks are required to maintain certain levels
of capital and liquidity, but if depositors panic and enough of them demand repayment, a bank
can very quickly become insolvent.
Problems in one bank can pass to other banks and from banks to other types of businesses like
a virus (this process is known as contagion). Eventually, this can build up to a financial crisis
and lead to a recession

1. Benefit (why other countries introduced deposit insurance)
• Pre-failure: The insurance helps to maintain stability in the financial system. It operates
primarily to stop bank runs where depositors, afraid that they will lose their money, all demand
repayment at once. Images of people lining up outside banks and at ATM machines all trying
to get their money out were a feature of the 2007-2008 Global Financial Crisis (GFC). If people
are confident that they will get their money back quickly from deposit insurance, they do not
need to “run” on their banks.
• Post-failure: protect depositors
Currently, if a bank fails in New Zealand, depositors could lose all or some of their savings.
Deposit insurance would change that and protect depositors’ savings. It operates like other
types of insurance. If disaster strikes and a bank fails, depositors’ savings would be repaid up
to a set limit.
(For NZ specifically) Under the Reserve Bank’s controversial open bank resolution policy, if
a bank is distressed and under statutory management, part of a retail depositor’s savings may


be frozen and used to recapitalise the bank, if shareholder and subordinated creditor funds
prove insufficient. Essentially, New Zealand retail depositors would have to bail out their
banks, unlike retail depositors in other countries who are protected by deposit insurance up
to a set limit.

2. Cost
– Moral hazard: deposit insurance will make the banks more susceptible to failure, which brings
with it the need for more, costly regulation. Protecting retail depositors from bank failure
would discourage depositors from monitoring and disciplining their banks by withdrawing
their savings if banks engage in overly risky activities. However, …
– Pricing: Deposit insurance is hard to price accurately and fairly; and brings with it difficult
boundary issues. Should it be just for banks – as is currently the case for OBR – or should it also
include finance companies, building societies and credit unions? How would we ensure that the
least risky banks do not end up subsidising the more risky?
– Historically: deposit insurance is not always effective in preventing bank runs by retail
depositors. UK-based Northern Rock suffered a classic retail run in 2007, despite a deposit
insurance scheme being in place.
– A recent paper by World Bank staff assessed how deposit insurance affected bank risk,
drawing on data across 96 countries during the pre-crisis (2004-06) and crisis (2007-09) periods.
They conclude that the "moral hazard effect" dominates in good times, in that the existence of a
deposit insurance scheme does lead to riskier behaviour by banks. During a crisis, bank risk is
lower and systemic stability greater in countries with deposit insurance coverage. By comparing
the magnitude of both effects, they conclude that "the overall effect of deposit insurance over the
full sample remains negative." In other words, they conclude that a deposit insurance framework
increasing the likelihood of bank failure is a greater concern than the absence of an insurance
framework worsening the impact of a crisis.
– WB: In countries that lack strong institutional environments, explicit deposit insurance can
end up doing more harm than good in terms of improving financial stability.
https://www.imf.org/external/pubs/ft/wp/2000/wp0003.pdf
– paper2:
Based on evidence for 61 countries in 1980–1997, this study finds that explicit deposit insurance
tends to increase the likelihood of banking crises, the more so where bank interest rates are


deregulated and the institutional environment is weak. Also, the adverse impact of deposit
insurance on bank stability tends to be stronger the more extensive is the coverage offered to
depositors, where the scheme is funded, and where it is run by the government rather than the
private sector.
https://www.imf.org/external/pubs/ft/wp/2000/wp0003.pdf
– paper3:
http://web.mit.edu/14.71/www/Calomiris%20deposit%20insurance.pdf

II. Resources:
Harvard style: https://student.unsw.edu.au/how-do-i-cite-electronic-sources
Google scholar, Journal article
https://scholar.google.com/scholar?hl=en&as_sdt=0%2C5&q=deposit+insurance&btnG=&o
q=deposit+ins
Google Translate
Paraphrase: https://myassignmenthelp.com/paraphrasing-step.php
Grammarly


































































































学霸联盟