The Valuation of Deposit Insurance Premiums Based on a Specific Bank’s Official Default Probability

Chiang, Shu Ling; Tsai, Ming Shann

Volume 23, Numbers 3 & 4 / September/December , Pages 141-272

Multinational Finance Journal, 2019, vol. 23, no. 3/4, pp. 141-167
Shu Ling Chiang , National Kaohsiung Normal University, Taiwan

Ming Shann Tsai , National University of Kaohsiung, Taiwan Corresponding Author

Abstract:
This study presents a formula for valuating a deposit insurance (DI) premium based on a specific official default probability. This formula can be used to flexibly determine the DI premium that reflects changes in economic circumstances. We provide a new estimation method to determine the implied asset risk based on the efficient frontier between asset value and asset risk. Doing so avoids the problem for estimating a bank’s assets and asset risk using market equity data. Empirical evidence shows current DI premium assumes that banks have too high default rates. We suggest the DI premium should be lower for banks that fully obey the financial supervisory regulations. Doing so should incentivize these banks to decrease their likelihood of default by strictly implementing financial regulations, thus stabilizing financial environment. We also suggest a new dynamic method to help them determine reasonable DI premiums and maintain the target level of DIF reserves.

Keywords : deposit insurance; premium; default probability; financial supervision
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