On the optimality of the deposit insurance premium

This paper proposes a methodology for determining the optimal insurance premium on bank deposits charged by a deposit insurer. To this end, we define a simple economy comprising a representative consumer/lender, a firm/borrower, a financial intermediary (bank), and a deposit insurer that partially covers the lenders’ deposits. The equilibrium of this economy is parameterized by the insurance premium rate, whose optimal value is the one that maximizes overall economic welfare. The equilibrium condition also yields a simple and testable relationship between the deposit interest rate and the insurance premium rate. Finally, we conduct empirical exercises to analyze how the optimal insurance premium rate responds to changes in the model’s fundamental parameters. • Deposit insurance premium rate that maximizes economic welfare. • Sensitivity of the insurance rate to market returns, volatility, and recovery rates. • Response of the deposit interest rate to changes in the insurance premium rate.