A Pure Bureaucratic-Entrepreneurial Theory of Deposit Insurance Adoption

Abstract

Based on Becker, Kane, Niskanen, and Peltzman’s ideas, we develop a model to explain why deposit insurance is adopted even though policymakers are aware of its pitfalls in both theory and practice. In our model, the regulator acts as both a bureaucrat and an entrepreneur to maximize his self-interest through administering a deposit insurance scheme. The theory postulates that adoption of deposit insurance is more likely under the following conditions: the scheme is (i) publicly administered and (ii) privately funded, with (iii) non-risk rated insurance premium and (iv) compulsory membership; and there is (v) a larger deposit market with (vi) at least two groups of banks (good vs. bad), (vii) lower government ownership of banks, and (viii) higher economic freedom, such that one group exerts its political influence and gains from deposit insurance. Empirically our theory is supported by the stylized facts, cross-country binary-choice regression results and a case study of Canada.