Deposit insurance in theory and practice

Having been hailed as the most important contribution to stabilising the US financial system after the 1929—33 crash, deposit insurance is now being blamed for financial destabilisation, particularly in emerging markets. This paper focuses on the relationship between deposit insurance and systemic stability in the banking system, drawing on recent experience in the USA, Europe and Japan. The conclusion is that if there is an embedded perception that in the last resort depositors will be protected beyond insurance limits then market-orientated solution to the problems of ‘moral hazard’ and excessive risk taking cannot work