Stealing Deposits: Deposit Insurance, Risk-Taking and the Removal of Market Discipline in Early 20th Century Banks
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.
The authors would like to thank the Gerard Caprio and David Wheelock as well as seminar participants at Columbia University, the Workshop in Macroeconomic Research at Liberal Arts Colleges, the Economic History Association, and the NBER Development of the American Economy meetings for valuable comments and suggestions. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Charles W. Calomiris & Matthew Jaremski, 2019. "Stealing Deposits: Deposit Insurance, Risk‐Taking, and the Removal of Market Discipline in Early 20th‐Century Banks," Journal of Finance, American Finance Association, vol. 74(2), pages 711-754, April. citation courtesy of