In my first post on this issue I was a bit short. I could not believe it was seriously being considered in Australia. It seems to have died a death in the media – and this is a good thing as it allows the whole idea to die a similar death.
To make sure this idea is left under the table, I thought I would compose a list of the reasons why it is silly. I will then leave the topic alone, hopefully never to be heard from again.
- As far as I know, no such system has ever escaped moral hazard. This is the process where, because you know that the deposit is insured you do something that would otherwise be silly. The US experience with the Savings and Loans institutions shows this clearly.
- Any such insurance scheme means that the good institutions will effectively subsidise the bad ones – if the premia paid relate to gross value of deposits, as is normal (and it is difficult to do it any other way), then a poorly run institution can expect to draw from this insurance and the good ones will not. This, combined with the moral hazard, increases the overall riskiness of the financial system.
- It gives the banks even more reason to constantly lobby governments, adding deposit insurance rates into the mix.
- This is a new tax, levied solely on banks (and passed on to their customers, as it must) and will result in increased fees. If it does not cost you money you will not be covered by it. The reason it is a tax is simple – if the premia paid and the other funds accumulated are not enough to cover a bank failure, then guess who will pay? It will come out of general revenue.
- It gives the government even more of an excuse to meddle in the
banks. After the AFSLs, CLERP9, Basel, the upcoming AML legislation, tax
changes (TOFA) and many others the banks are forgetting how to borrow
and lend while they try and work out how to comply with increasingly
sillydifficult legislation. All of this, while on its face reduces risk, in fact is getting close to increasing it.
- There are much cheaper ways to achieve the same effect, without the moral hazard. Just ask the banks to offer accounts with no interest (or CPI linked interest) that are fully backed by government issued paper. If it needs a subsidy to do it, then consider if it is worth the subsidy. It has got to be cheaper than deposit insurance.
There may have been a few reasons that I missed. Please feel free to add more in comments. If you can think of a reason to implement deposit insurance, feel free to put that in too. I am struggling to think of one.
[UPDATE] If you want a contrary view, try Professor Quiggin’s article from 2002. I disagree, with him, for the reasons above. I would find it much more reasonable just to make it plain to people that their deposits are not insured and leave it at that.[/UPDATE]