Staff Report 274

Risky Collateral and Deposit Insurance

Narayana Kocherlakota | Consultant

Published August 1, 2000

This paper provides a new rationalization for deposit insurance and systemic disintermediations. I consider an environment in which borrowers face no penalty for failing to repay obligations except the loss of their collateral. I assume that this collateral has aggregate risk. For a subset of the exogenous parameters, I demonstrate that an optimal arrangement features deposit insurance. For a strictly smaller set of parameters, it is optimal in some states of the world to have systemic disintermediation and concomitant falls in real output.

Published In: Advances in Macroeconomics (Vol. 1, No. 1, 2001)

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