The additional interest that depositors will want from putting their
money in a commercial bank rather than in something ultra-safe (like government
debt or simply holding monetary base) will simply reflect the additional risk
involved. Plus to insure against that risk, the insurance premium will have to
reflect and be equal to the risk involved. Ergo the premium wipes out the extra
interest.
However, that argument could be attacked on the grounds that insurance
spreads risks, thus deposit insurance will in fact cut costs as compared to
where depositors insure themselves.
My answer to the latter point is that it ignores the difference between on
the one hand potentially catastrophic / ruinous risks and on the other hand,
more manageable risks. To be exact, anyone undertaking a potentially ruinous
risk will want a relatively large reward for doing so. Thus if that risk is
spread in such a way that no individual faces a ruinous risk, the total cost of
insurance will decline.
However, commercial banks are one huge “risk spreading” operation ANYWAY:
i.e. a typical commercial bank might have a million or more depositors and an
approximately equal number of borrowers. So risks are shared between those million
or so depositors.
Ergo, commercial banks already and very largely dispose of the risk of
ruinous loss (by that I mean depositors losing more than 75% or so of their
money). And the latter idea is actually backed up by figures from the FDIC
relating to the relationship between assets and liabilities of small FDIC
insured banks which go bust. That is, it is unheard of for insolvent banks to
have zero assets. Rather, assets normally amount to about 75% of liabilities,
with an asset to liability ratio of less than 50% being a rarity.
As to large banks, they by definition involve even more risk sharing, so
the chance of any depositor (absent deposit insurance) facing ruinous loss is
even smaller.
Minor risks.
As distinct from potentially ruinous risk, there are manageable or minor risks. In
the case of the latter, working out the required insurance premium is a very
mundane matter. To illustrate, if the chance of depositors losing 50% of their
money in any one year is 1%, then a premium needs to be 1% of 50%, i.e. 0.05%
of the capital sum insured. And that 0.05% won’t change if the risk is spread
(e.g. if deposit insurance is implemented).
So I’m sticking to my story that deposit insurance achieves nothing.
That of course leaves the question as to whether depositors are not
entitled to some form of near 100% safe form of saving or lodging their money.
Well of course they are! And the way to do it has been set out by Laurence
Kotlikoff, Matthew Kline and by this lot.
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