An evaluation of the IMF best-practice deposit insurance system: lessons from the United States experience

Abstract

Many countries have experienced slow economic growth as a result of financial instability. In response to this problem, many countries have established deposit insurance systems (DIS). However, deposit insurance systems often suffer from three fundamental problems moral hazard, adverse selection, and the agency problem. Any well-designed DIS must seek to minimize these problems. As an international lending institution, the IMF is concerned with the problem of financial instability, and its preferred solution has been the creation of DIS. Gillian Garcia of the IMF has proposed a model for a best-practices DIS which IMF authorities have adopted for countries that are about to establish such a system. However, the Garcia-IMF model is based only on post-1991 U.S. experience and recent experiences of other countries. It omits the long and rich pre-1991 experience of the individual U.S. states, the FSLIC, NCUSIF, and pre-1991 FDIC. When the Garcia-IMF model was applied to all countries that have explicit DIS. the results were unrealistic. Countries with well-developed financial systems were rated as "poor", and countries with less-developed financial systems were rated as "good". When the model was applied to the pre-1991 U.S. bank insurance programs the results were again unrealistic because successful programs were rated as "poor" and less successful programs were rated as "good". This dissertation identified the institutional features that were responsible for the success of certain U.S. bank insurance programs, such as those of Indiana. Ohio, and Iowa. These factors are proposed as essential features of a best-practice DIS. When the proposed model was applied to all countries having an explicit DIS. the results were realistic: DIS rated as "good" were found only in countries with well-developed financial systems, and DIS rated as "poor" were found mostly in countries with less-developed financial systems. When the model was applied to the historical U.S. data, the results were again realistic: programs rated "good" were those known to be the most successful, and programs rated "poor" were those known to be failures. A modified Garcia-IMF model incorporating the factors identified in this research would better address the fundamental problems of DIS. Such a model would be of value to any state or country instituting or re-structuring a deposit insurance system.