Scrapping deposit insurance is a perfectly respectable idea
Our friends the Centre for Policy Studies have a report (pdf) out today, by banker/adviser Andreas Wesemann, which argues for the abolition of deposit insurance. This shocked and appalled some, including All Souls professor Kevin O'Rourke, who asked Twitter if Wesemann and the CPS could possibly be serious.
Yes, they could be serious. Scrapping deposit insurance is an idea with a fairly impressive pedigree. O'Rourke is presumably aware of the hugely-cited 2002 paper "Does deposit insurance increase banking system stability? An empirical investigation", in the prominent Journal of Monetary Economics (the 22nd highest impact econ journal by ideas.repec.org's most sophisticated ranking system). If he wasn't, Garett Jones pointed it out to him on Twitter. It looks at 61 countries between 1980 and 1997 and finds that explicit deposit insurance tends to lead to more banking crises.
This is, of course, precisely what the CPS paper argues. And one of the JME paper authors, with different collaborators, updated the analysis in 2015, looking at data from up to 2013 from across the world, with largely unchanged results (pdf). They point out that insuring deposits may restrain bank runs, but it encourages worse sorts of instability, and drives bank risk-taking. We might add that if debt is a worry, then subsidising deposits but not equity is yet another intervention encouraging debt over other, potentially less worrisome, ways of funding investment.
It's true that not every paper supports the CPS conclusion. Some find that deposit insurance cushions the market in bad times, even if it makes these bad times worse. Others find that the runs that a no-insurance regime allows are a key element of discipline in the system, working toward higher long run stability even as they destabilise in the short run. In the absence of systematic reviews and meta-analyses I can only give my own impression of the literature, which it seems to me sides mostly with the 2002 finding from Demirgüç-Kunt & Detragiache.
But whatever the overall tenor of the research, it's clearly an academically popular position that deposit insurance brings with it clear dangers. So I'd ask O'Rourke and others to tone down the shock and horror—abolishing deposit insurance is a perfectly respectable position. Now how about reconsidering all that Basel III business...