A research of deposit insurance mechanism overcoming adverse selection

In the deposit insurance market with asymmetrical information, adverse selection means that the risk-prone banks are more likely to join in the deposit insurance system than those are better managed especially in a country with voluntary deposit insurance system. This paper designs an optimal deposit insurance mechanism overcoming adverse selection in deposit insurance by utilizing the theory and methodology of mechanism designing. The study shows that, there exists an optimal deposit insurance mechanism with flat-premium satisfying incentive compatible conditions in the deposit insurance market with asymmetric information, but the bank with low-risk loan portfolios subsidizes - the bank with high-risk loan portfolios comparing to the deposit insurance mechanism under symmetrical information.