chapter 16: learning objectives
DESCRIPTION
Chapter 16: Learning Objectives. Origins & Principles of Deposit Insurance in Canada The CDIC: Structure & Operations The International Experience with Deposit Insurance Policy Issues: Moral Hazard, Adverse Selection & Government Intervention. Origins and Purpose of Deposit Insurance. - PowerPoint PPT PresentationTRANSCRIPT
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Chapter 16:Learning Objectives
Origins & Principles of Deposit Insurance in Canada
The CDIC: Structure & Operations The International Experience with
Deposit Insurance Policy Issues: Moral Hazard, Adverse
Selection & Government Intervention
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Origins and Purpose of Deposit Insurance
Fear of systemic bank failures and the externalities involved led many governments to introduce different forms of deposit insurance opposed by Chartered banks
The CDIC is the institution responsible for administering deposit insurance most financial institutions participate and there is
involvement by the BOC and the Finance Dept How are bank failures resolved?
Pay off depositors merger (forced or voluntary) transfer to another financial institution bailout
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Deposit Insurance Operation (cont’d)
What is covered by deposit insurance? Table 16.1 $CDN deposits of 5 yrs or less Money orders, travelers’ cheques limited number of RRSPs, RRIFs liability limited to $100,000 BUT a variety of loopholes
exist to effectively increase protection joint accounts multiple deposits at different institutions provincial supplementary plans
How is it financed? Flat fee at first, but risk based premiums now in place
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Deposit Insurance in Other Countries
Canada was not the first to offer deposit insurance
Deposit insurance elsewhere motivated by different considerations
Not all are purely public plans There exists a wide variety of plans,
premiums, and coverage types
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Deposit Insurance Around the World
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The Problem with Insurance:Moral Hazard
Asymmetric Information means that insured (i.e., banks) knows more about own risks than institutions who insure (CDIC)
As a result, institutions are effectively shielded from risk-taking resulting in more risk-taking than would otherwise be the case [MORAL HAZARD]
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The Problem with Insurance:Adverse Selection
The availability of insurance means that individuals are less prone to assess the risk-return relationship and will maximize return (monetary & non-monetary) regardless of risk
The probability of bank failure is changed by the behaviour of depositors who are influenced by the presence of deposit insurance [ADVERSE SELECTION]
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Moral Hazard :A Graphical Exposition
Legend: H=high risk; L= Low risk
Simplified version of Figure 16.1(A)
H L
Before Deposit Insurance
H L
With Deposit Insurance
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Adverse Selection :A Graphical Exposition
Legend: H=high risk; L= Low risk
Simplified version of Figure 16.1(B)
Depositors View Insurer’s View
All banks H L
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Should Government Run Deposit Insurance?
YES NO
To prevent market failureexacerbated by the “externalities” problem
Should be treated like any other form of insurance
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Can the Existing Deposit Insurance System be Improved?
Insure only minimal number of deposits risk-based premiums: a version
introduced in Canada improved corporate governance voluntary CDIC membership money market mutual funds: a version
in existence in Canada
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Summary
Insurance against depositor loss is called deposit insurance
CDIC administers deposit insurance in Canada International comparisons show that deposit insurance
is administered in a wide variety of ways across countries
All forms of insurance suffer from the twin problems of moral hazard and adverse selection
Recent policy discussions have focused on who should run deposit insurance and the role of government