DP16893 Common Deposit Insurance, Cross-Border Banks and Welfare
We study the effects of the introduction of a supranational authority responsible for common deposit insurance in a model of cross-border banks with both endogenous risk-taking and within-group risk-sharing possibilities. With national deposit insurance, local authorities inefficiently ring-fence resources flowing from healthy to impaired subsidiaries for high asset correlation. The anticipation of ring-fencing discourages cross-border bank integration. Common deposit insurance removes ring-fencing and encourages cross-border integration, but has an ambiguous impact on the banks' risk-taking incentives.
Overall, common deposit insurance increases welfare when banks are sufficiently risky, but otherwise can lead to excessive cross-border integration and lower welfare.
