Deposit insurance in a sequential-service constrained environment

Abstract

We study the effect of a deposit insurance scheme (DIS) in an economy with multiple isolated banks. Participant banks fund the scheme, which follows a pre-determined insurance payment scheme. An external player transfers insurance benefits to all banks where depositors are running. The total insurance payment depends on resources collected by the external authority and the number of eligible queues to receive the insurance benefit. We discuss the effect of DIS on the optimal payment contract. More specifically, we analyze the existence of bank-run equilibria and whether the optimal payment contract is incentive-compatible. We find that DIS prevents bank-run equilibria at the same time that it may expose the environment to contagion. We also see that the insurance policy relaxes the truth-telling condition for general parameters.