Essays on Banking Crises and Deposit Insurance

My research focuses on the reasons for banking crises and the corresponding policy rulesthat could help prevent such crises. This abstract briefly reviews the two essays in mydissertation. The first essay focuses on the optimal mechanism design of the depositinsurance system while the second essay studies the impact of international illiquidity ondomestic banking crises.The Recent Deposit Insurance Reform in the U.S. raised the coverage limit forcertain types of deposits. In chapter II, I study the optimal coverage limit in a model ofdeposit insurance in the banking system. Because of the coverage limit, depositors haveincentives to monitor the bank’s risk-taking behavior, threatening banks with thewithdrawal of deposits if necessary. The model includes risk-taking banks,heterogeneous depositors, and a benevolent insurance company providing depositinsurance. I find that partial coverage combined with risk-sensitive premia in thepresence of capital requirements can improve social welfare and manage banks’ risktakingbehavior. Moreover, when a partial coverage limit is in place, banks are better offby finding a balance between the higher premia and the depositors’ monitoring andwithdrawals.Unlike chapter II, chapter III focuses on the role played by internationalilliquidity. I build a dynamic general equilibrium model (DGEM) of a small, openeconomy. The features I include in the model are nontrivial demands for fiat currencies,unanticipated sunspots, and financial/banking crises originated by sudden stops of foreign capital inflows are. This chapter gives us a better understanding of theperformance of alternative exchange rate regimes and associated monetary policiesunder a simple setup. I show the existence of multiple equilibria that may be rankedbased on the presence of binding information constraints and on welfare. Moreover, Ishow that a strong connection of the scope for existence and for indeterminacy ofequilibria with the underlying policy regime. I also find that the presence of bindingmultiple reserve requirements help in reducing the scope for financial fragility and panicequilibria.