Jan Kregel: fiat money requires deposit insurance with a ‘contingent guarantee’ of the central bank
From the archives of the Levy institute
In a new policy note, Jan Kregel draws out some of the policy lessons of the Cypriot deposit tax episode for plans to create a system of EU-wide deposit insurance. In addition to the necessity of a strong central bank (the ECB in this case) standing behind the deposit insurance scheme (which does not appear to be part of the current plans), Jan Kregel explains why a certain amount of moral hazard is inescapable.
We can see this by looking at two types of deposits that correspond to the dual functions of banks:
* deposits of currency and coin,
* and deposits created when loans are made.
If a bank makes bad loans … “it is the failure of the holder of the second type of deposit [loan-created deposits] to redeem its liability that is the major cause of bank failure” — the first type of depositor (of currency and coin) should not bear the brunt of these bad decisions. The role of deposit insurance, one might argue, is to provide such protection.
But since deposit insurance has to be extended to all of a banks’ deposits (up to a certain level), including those created by loans, moral hazard is inevitable. Ideally, deposit insurance would be structured in such a way as to distinguish between deposits based on currency and coin and deposits generated through loans, as well as between deposits created by good and bad loans (loans that default). But if you examine how the banking system functions, says Kregel, this isn’t operationally possibl … it is impossible in practice to make these distinctions between reserve deposits, defaulted-loan-created deposits, and deposits created by loans that are current. It is for this reason that there are limits on the size of insured deposits based on the presumption that the first type of deposits will be relatively small household deposits created by the transfer of reserves and used as means of payment or store of value. It thus limits coverage of the other types of deposits. However, this is clearly inequitable for the deposits held by borrowers who are still current on their loans.
As he explains, with some help from Minsky, it is the means of payment function that makes these distinctions practically impossible (for more on why this is, read the note here). Kregel concludes that “It would thus seem impossible to design a truly fair deposit insurance scheme that eliminates the inherent moral hazard and the necessity of a contingent guarantee of the central bank.”
Leave a comment
—– look inside —– $5.94 / $20.00
—– look inside —– $4.90 / $8.00
—– look inside —– $15.99
—– look inside —– $5.99 / 12.99
—– look inside —– $5.93 / $12.99
—– look inside —– $4.97 / $9.90
—— Ugarteche, Puyana and Madi ——
Gerson Lima / Maria Alejandra Madi
Edward Fullbrook and Jamie Morgan
————— Michael Hudson ————–
Maria Alejandra Madi / Jack Reardon
————- Edward Fullbrook ————-
—————— Steve Keen —————–
————— Richard Smith —————
————– Gustavo Marques————
– Victor Beker and Beniamino Moro –
————– Lars Pålsson Syll ————-
—————– Stuart Birks —————-
Edward Fullbrook and Jamie Morgan
———— Armando Ochangco ———-
Shimshon Bichler / Jonathan Nitzan
————— Mauro Gallegati ————–
————— Herman Daly —————-
————— Asad Zaman —————
—————– C. T. Kurien —————
————— Robert Locke —————-
Real-World Economics Review Blog 
The monetary sovereign ITSELF is the only proper provider of a risk-free storage and transaction service for its fiat and ALL government deposit insurance should be abolished shortly after such a service is established.
Let’s 100% private banks issue all the credit they dare but let them and their 100% voluntary depositors and other creditors bear all the risk.
“Let’s 100% private banks issue all the credit they dare but let them and their 100% voluntary depositors and other creditors bear all the risk.”
I think you forgot, “And let them be subject to regulation so that they can never be large enough or leveraged enough to take down the world economy with them when they go.”
We need to always remember to do the mathematically solvent thing while we are doing the “fair” thing.
Let God enforce fairness if He so desires; we should concern ourselves with ethics and justice.
But would you keep an account at a bank without government deposit insurance? I wouldn’t. Nor would most other people.
I stand by what I said. 100% private banks should be able to leverage all they dare. And by 100% private, I mean entirely voluntary depositors and not the captive audience the banks now enjoy.
If those 100% mega-leveraged private banks existed on another planet not economically linked to ours, perhaps. Otherwise, no. Regulate them in a way that reflects their inter-connectedness with the entire banking/economic/social system in which they participate. Fairness is central to a just ethical framework, imperfect as it may be. But this is as He has designed us, and we must discern His will as best we can.
The ‘contingent guarantee’ is not and cannot be based on any deposit of physical assets. If anything, this makes the Minsky problem worse by enabling massive short squeezes at the worst possible time. The only secure contingency guarantee that matters for stabilizing banking is a nations sovereign ability to control its borders and tax its citizens, businesses, and importers. Once the reigns of government and public media have been handed to a taxation and tariff averse minority, the seeds of collapse have been planted.
We should have a smaller quantity of dust money held as 100% reserves, and everything else should be stock funds, as advocated by Kotlikoff, Kumhof, and others.
… fiat money