Essays on Banking Crises and Deposit Insurance

My research focuses on the reasons for banking crises and the corresponding policy rules that could help prevent such crises. This abstract briefly reviews the two essays in my dissertation. The first essay focuses on the optimal mechanism design of the deposit insurance system while the second essay studies the impact of international illiquidity on domestic banking crises. The Recent Deposit Insurance Reform in the U.S. raised the coverage limit for certain types of deposits. In chapter II, I study the optimal coverage limit in a model of deposit insurance in the banking system. Because of the coverage limit, depositors have incentives to monitor the bank?s risk-taking behavior, threatening banks with the withdrawal of deposits if necessary. The model includes risk-taking banks, heterogeneous depositors, and a benevolent insurance company providing deposit insurance. I find that partial coverage combined with risk-sensitive premia in the presence of capital requirements can improve social welfare and manage banks? risktaking behavior. Moreover, when a partial coverage limit is in place, banks are better off by finding a balance between the higher premia and the depositors? monitoring and withdrawals. Unlike chapter II, chapter III focuses on the role played by international illiquidity. I build a dynamic general equilibrium model (DGEM) of a small, open economy. 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 the performance of alternative exchange rate regimes and associated monetary policies under a simple setup. I show the existence of multiple equilibria that may be ranked based on the presence of binding information constraints and on welfare. Moreover, I show that a strong connection of the scope for existence and for indeterminacy of equilibria with the underlying policy regime. I also find that the presence of binding multiple reserve requirements help in reducing the scope for financial fragility and panic equilibria.