This note elaborates on a recent article by Chan, Greenbaum and Thakor
(1992) who contend that fairly priced deposit insurance is incompatible
with
free competition in the banking sector, in the presence of adverse
selection.
We show here that at soon as one introduces a real economic motivation
from
private banks to manage the deposits from the public, then fairly priced
deposit insurance becomes possible. However, we also show that such
a fairly
priced insurance is never desirable, precisely ...
This note elaborates on a recent article by Chan, Greenbaum and Thakor
(1992) who contend that fairly priced deposit insurance is incompatible
with
free competition in the banking sector, in the presence of adverse
selection.
We show here that at soon as one introduces a real economic motivation
from
private banks to manage the deposits from the public, then fairly priced
deposit insurance becomes possible. However, we also show that such
a fairly
priced insurance is never desirable, precisely because of adverse
selection.
We compute the characteristics of the optimal premium schedule, which
trades
off between the cost of adverse selection and the cost of ``unfair
competition ''.
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