Question 15.2: “The existence of deposit insurance makes it particularly im...

Risk Management and Financial Institutions

“The existence of deposit insurance makes it particularly important for there to be regulations on the amount of capital banks hold.” Explain this statement.

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Deposit insurance means that depositors are safe regardless of the risks taken by their financial institution. It is liable to lead to financial institutions taking more risks than they otherwise would because they can do so without the risk of losing deposits. This in turn leads to more bank failures and more claims under the deposit insurance system. Regulation requiring the capital held by a bank to be related to the risks taken is necessary to avoid this happening.

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