Deposit insurance systems are designed to balance the benefits of preventing bank runs and protecting ordinary savers against the costs of reduced market discipline and potential burdens on taxpayers. Design flaws of deposit insurance make the benefits too low and the costs too high. This paper presents an example in which solvent banks can effectively manage runs, depositors discipline banks to a reasonable extent, and taxpayers have a fair deal. It has three key features: the bank’s authority to activate deposit insurance early, a coinsurance scheme that transfer money from those who run on solvent banks to those who stay put, and a shareholder position for taxpayers. Early activation of deposit insurance prevents fire sales of assets and provides opportunities to verify the bank’s solvency. The coinsurance scheme weakens the incentive to run and strengthens the incentive to hold on to their accounts. As shareholders, taxpayers receive dividends in normal times in exchange for large payouts in catastrophic events.
Friedman, Milton and Anna J. Schwartz, (1963), A Monetary History of the United States, 1967-1960, Princeton University Press, Princeton.https://press.princeton.edu/books/paperback/9780691003542/a-monetary-history-of-the-united-states-1867-1960
Keeley, Michael C., (1990), Deposit Insurance Risk and Market Power in Banking, American Economic Review 80(5), 1183-1200. https://www.jstor.org/stable/2006769
Merton, Robert C., (1977), An Analytic Derivation of the Cost of deposit Insurance and Loan Guarantees, Journal of Banking and Finance 1(1), 3-11.
https://www.sciencedirect.com/science/article/abs/pii/0378426677900152Park, Sangkyun, (1991), Bank Failure Contagion in Historical Perspective, Journal of Monetary Economics 28(2), pp. 271-286. https://www.sciencedirect.com/science/article/abs/pii/030439329190054R
Park, Sangkyun and Stavros Peristiani, (1998), Market Discipline by Thrift Depositors, Journal of Money, Credit and Banking 30(3), pp.347-364. https://www.jstor.org/stable/2601105