This paper undertakes a simple general equilibrium analysis of the consequences of deposit insurance programs, the way in which they are priced and the way in which they fund revenue shortfalls. We show that the central issue is how the government will make up any FDIC losses. Under one scheme for making up the losses, we show that FDIC policy is irrelevant: it does not matter what premium is charged, nor does it matter how big FDIC losses are. Under another scheme, all that matters is the magnitude of the losses. And there is no presumption that small losses are “good.” We also show that multiple equilibria can be observed and Pareto ranked. Some economies may be “trapped” in equilibria with inefficient financial systems. Our analysis provides counterexamples to the following propositions. (1) Actuarially fair pricing of deposit insurance is always desirable. (2) Implicit FDIC subsidization of banks through deposit insurance is always undesirable. (3) “Large” FDIC losses are necessarily symptomatic of a poorly designed deposit insurance system.
Published in: _Journal of Monetary Economics_ (Vol. 49, No. 6, September 2002, pp. 1235-1260), https://doi.org/10.1016/S0304-3932(02)00143-5.