Question

What are the pros and cons of government-provided deposit insurance? Do you think governments should insure bank deposit? (Maximum 500 words.)

Answer 1

When any deposit is made by the customers they would look out for their interest and hence if banks make wrong choices in their investments they would remain liable to their creditors in repaying off their loans. Deposit Insurance acts as a shield as it protects the liability of the creditors and encourages them to provide deposits. The pros & cons that government-provided deposit insurance would have is as follows;

              Pros:

1. It encourages the consumers to deposit their money in the banks.
2. It brings stability to the system as liquidity crunch is never a healthy scenario for any banks.
3. Since more consumers will be inclined to deposit their money’s in the bank, banks will lend them at a lower rate thereby allowing the (economy-industry) to grow.

1. Deposit Insurance encourages banks to take excessive risks.
2. Competition among banks will never be the same as the consumers will know that their money is safeguarded by the deposit insurance.
3. Deposit Insurance does not allow the difference between safe banks and unsafe banks to look into as consumers will never look out to move their funds to the safe banks due to the presence of the deposit insurance.

It is good for the government to bail out the banks when they are in an insolvent scenarios as large amount of consumers would lose their money when the banks fail. It is although a responsibility of the banks too to make safe decision making rather than risky ones. There should also be vigilance from the Federal Banks to take charge and inform the government about the risky statues of any bank as lot many things are interlocked when a bank fails.