Which Banks Choose Deposit Insurance? Evidence of Adverse Selection and Moral Hazard in a Voluntary Insurance System.

This article investigates adverse selection and moral hazard in the voluntary deposit insurance system of Kansas, which operated from 1909 to 1929. Regulations were imposed to limit risk-taking and membership was made voluntary to assuage objections that insurance forces conservative banks to protect depositors of high-risk institutions. The authors find, however, that risk-prone banks were the most likely to join the system at its inception. Using a simultaneous equations model, they also detect both adverse selection and moral hazard behavior throughout the system's first ten years. Copyright 1995 by Ohio State University Press.