Narrow Results

This paper investigates the application of option pricing to calculate the premium of deposit insurance in Thailand during the 1992-1996 period. In addition to applying the traditional Black- Scholes model, the barrier model of Boyle and Lee (1994) is examined. The barrier model takes the management (owners) action into account: the management (owners) may have a strong incentive to increase the volatility of the bank's assets, since this action increases the value of their equity. As suggested by the stylized evidence, most financial institutions in Thailand were "family owned", and there was inadequate corporate governance to prevent the incentive problems. The barrier model seems to fit the description of financial institutions in Thailand. The overall results show that the deposit insurance premiums of failed financial institutions are higher than the premiums of non-failed institutions. The evidence suggests that the option framework seems to be appropriate for pricing the premium: higher risk institutions pay higher insurance premiums. The results also show that the risk-based insurance premiums vary across time and on average are less than the premiums charged by the Financial Institutions Development Fund (FIDF).

The main purpose of this paper is to model bank spread behavior under capital regulation and deposit insurance. Comparative static results show that an increase in the capital-to-deposits ratio or the deposit insurance decreases the bank's interest margin or spread. It is also shown that an increase in the equity that implies its opportunity cost of the coupon rate on the fixed leg decreases the margin. Previous research on market-based evaluations of bank equity has modeled the bank as a narrowing banking firm with risky assets and insured liabilities. The equity of the bank is viewed as a call option on its risky assets. No attempt was made to explicitly analyze a synergy between lending and deposit-taking, and, in our view, the equity of the bank is viewed as a swap option on coupon bonds. Synergy banking, particularly in the return to retail banking, is important in distinguishing banks from other lenders such as finance companies and mutual fund institutions. These other lenders call for the breaking up of banks into separate lending and deposit-taking operations, respectively. Our findings provide an insight for synergy banking operations concerning regulated bank spread behavior in the return to retail banking.

US debt ceiling crises in 2011 and 2013 were marked by significant outflows from money market funds (MMFs). This study evaluates the behavior and motivations of investors redeeming from MMFs during these crises. We find that the majority of redemptions reflect a generalized flight-to-liquidity and are, therefore, primarily a function of the liquidity needs of a fund’s investor base. Funds holding Treasury securities at greatest risk of default or with market values below their $1 share price experience flows that are insignificantly different from other funds, all else equal. We also find evidence that a significant portion of the outflows stem, not from liquidity concerns, but from an opportunistic yield play on the repo market created by the crises. Finally, we offer anecdotal evidence that the government’s guarantee of bank deposits had the perverse effect of encouraging outflows from MMFs during the 2011 crisis.

This paper addresses the following question: Are banks special firms that can achieve their goals only with high leverage, above and beyond what is considered acceptable for industrial corporations?

This question is related to the issue of the cost of capital and how it is affected by leverage. If we accept the Modigliani–Miller (M&M) theorem (1958), then the capital structure is irrelevant for both the cost of capital and the value of the bank. Specifically, the M&M hypothesis argues that higher levels of equity capital reduce bank leverage and risk, leading to an offsetting decline in banks’ cost of equity capital. Hence, we ask the question whether banks are special firms such that M&M theorem does not apply to banks.

We show that M&M propositions cannot be applied for banks primarily because of explicit guarantees and subsidies that provide incentives for increasing leverage. Then, some of the risk faced by the bank is transferred at no cost to the providers of these guarantees and subsidies, giving banks the incentive to increase leverage as much as they can. We show that under perfect market conditions, when risk is fairly priced, this opportunity vanishes.

Deposit insurance is a critical instrument in modern financial systems for protecting depositors’ interests and promoting financial stability. The deposit insurance finance model, which is based on the standard power option pay-off, has been considered in this paper using the Picard–Lindelöf Iteration Method (PIM). Utilizing the repetitive framework of the Picard–Lindelöf iteration approach offers insights into the dynamic behavior of deposit insurance premiums and risk assessments. The study highlights the significance of using the Picard iteration technique to better understand deposit insurance pricing and its implications for financial institutions and regulatory bodies.

In this chapter, we propose the structural model in terms of the Stair Tree model and barrier option to evaluate the fair deposit insurance premium in accordance with the constraints of the deposit insurance contracts and the consideration of bankruptcy costs. First, we show that the deposit insurance model in Brockman and Turle (2003) is a special case of our model. Second, the simulation results suggest that insurers should adopt a forbearance policy instead of a strict policy for closure regulation to avoid losses from bankruptcy costs. An appropriate deposit insurance premium can alleviate potential moral hazard problems caused by a forbearance policy. Our simulation results can be used as reference in risk management for individual banks and for the Federal Deposit Insurance Corporation (FDIC).