Deposit Insurance and Market Discipline

Deposit insurance is a widely adopted policy to promote financial stability in the banking sector. Deposit insurance helps ensure depositor confidence in the financial system and prevents contagious bank runs, but it also comes with an unintended consequence of encouraging banks to take on excessive risk. Recent failures of Silicon Valley Bank and First Republic Bank has rekindled the debate on the impact of deposit insurance on risk-taking and how deposit insurance should be designed and implemented. In this paper, we review the economic costs and benefits of deposit insurance and highlight the importance of institutions and specific design features on how well deposit insurance schemes work in practice.