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Deposit insurance, credit risk and capital adequacy: a note

Author: Dermine, Jean INSEAD Area: Finance Series: Working Paper ; 92/19/FIN Publisher: Fontainebleau : INSEAD, 1992.Language: EnglishDescription: 20 p.Type of document: INSEAD Working Paper Online Access: Click here Abstract: Previous research on deposit insurance and capital adequacy has modelled the bank as a corporate firm with risky assets and insured liabilities. No attempt has been made to analyse explicitly the risk characteristics of bank assets. The purpose of this paper is to model bank lending and calculate credit-risk sensitive insurance premia. The lending function of banks creates the need to model equity as a "capped" call option. Previous estimates of insurance premia which are based on a "naked" call assumption could be biased. Moreover, it is shown that the Modigliani-Miller capital structure irrelevance theorem implies the ineffectiveness of bank capital regulations
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Previous research on deposit insurance and capital adequacy has modelled the bank as a corporate firm with risky assets and insured liabilities. No attempt has been made to analyse explicitly the risk characteristics of bank assets. The purpose of this paper is to model bank lending and calculate credit-risk sensitive insurance premia. The lending function of banks creates the need to model equity as a "capped" call option. Previous estimates of insurance premia which are based on a "naked" call assumption could be biased. Moreover, it is shown that the Modigliani-Miller capital structure irrelevance theorem implies the ineffectiveness of bank capital regulations

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