Moral Hazard and the deposit insurance cap: a case study of Northern Rock and Silicon Valley Bank

The main contention of this article is that government insurance for bank deposits should be unlimited. In spite of claims made in the literature concerning the moral hazard dangers of deposit insurance schemes, I argue that these claims are unconvincing; indeed, the empirical record - discussed here in relation to Northern Rock and SVB - demonstrates that uninsured depositors exhibit similar behaviour to their insured counterparts, undermining the claim that limiting insurance induces risk-monitoring. In contrast, there is strong evidence that in developed jurisdictions with established, mature regulatory institutions, deposit insurance does not result in excessive risk-taking on the part of banks. The significant financial stability benefits accruing to insuring bank deposits include the elimination of depositor runs, a reduction in the incentives for unregulated bank-like financial intermediation (shadow banking), and heightened competition. Activity restrictions and other measures can reduce any heightened risk-taking which emerges as a result of wider insurance coverage.