Fair premium rate of the deposit insurance system based on banks’ creditworthiness

Naoyuki Yoshino, Farhad Taghi Zadeh Hesary, Farhad Nili

Research output: Contribution to journalArticle

Abstract

Purpose: Deposit insurance is a key element in modern banking, as it guarantees the financial safety of deposits at depository financial institutions. It is necessary to have at least a dual fair premium rate system based on creditworthiness of financial institutions, as considering singular premium system for all banks will have moral hazard. This paper aims to develop theoretical and empirical model for calculating dual fair premium rates. Design/methodology/approach: The definition of a fair premium rate in this paper is a rate that covers the operational expenditures of the deposit insuring organization, provides it with sufficient funds to enable it to pay a certain percentage share of deposit amounts to depositors in case of bank default and provides it with sufficient funds as precautionary reserves. To identify and classify healthier and more stable banks, the authors use credit rating methods that use two major dimensional reduction techniques. For forecasting nonperforming loans (NPLs), the authors develop a model that can capture both macro shocks and idiosyncratic shocks to financial institutions in a vector error correction model. Findings: The response of NPLs/loans to macro shocks and idiosyncratic innovations shows that using a model with macro variables only is insufficient, as it is possible that under favorable economic conditions, some banks show negative performance due to bank level reasons such as mismanagement or vice versa. The final results show that deposit insurance premium rate needs to be vary based on banks’ creditworthiness. Originality/value: The results provide interesting insight for financial authorities to set fair deposit insurance premium rate. A high premium rate reduces the capital adequacy of individual financial institutions, which endangers the stability of the financial system; a low premium rate will reduce the security of the financial system.

Original languageEnglish
JournalStudies in Economics and Finance
DOIs
Publication statusPublished - 2019 Jan 1

Fingerprint

Creditworthiness
Premium
Deposit insurance
Financial institutions
Deposits
Insurance premium
Non-performing loans
Financial system
Vector error correction model
Guarantee
Banking
Economic conditions
Expenditure
Loans
Empirical model
Authority
Innovation
Safety
Moral hazard
Idiosyncratic shocks

Keywords

  • Deposit insurance premium rate
  • Forecasting nonperforming loans
  • Idiosyncratic shocks

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

Cite this

Fair premium rate of the deposit insurance system based on banks’ creditworthiness. / Yoshino, Naoyuki; Taghi Zadeh Hesary, Farhad; Nili, Farhad.

In: Studies in Economics and Finance, 01.01.2019.

Research output: Contribution to journalArticle

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