Journal Press India^®

Author Details ( * ) denotes Corresponding author

Deposit Insurance, a scheme introduced in India in 1961, provides insurance to the bank depositors in case a bank fails in future. However, the policy leads to the problem of moral hazard and adverse selection, and the consequential surged risk levels as it lures bank managers to invest in risky projects for higher returns. The aim of the paper is to construct a relation between deposit insurance and bank risk for all Indian scheduled commercial banks (excluding regional rural banks). It is inferred that deposit insurance significantly increases the risk levels of banks, given the constraint that total deposits increase faster than insured deposits. A graphical representation of risk return trade off through the bank's utility and feasible portfolio curves provide empirical support for the same. It also demonstrates that banks lower risk taking during high risk in the economy. Few relevant policy prescriptions are also proposed along with the findings.

Keywords

Deposit insurance; Bank risk; Moral hazard; Borrowings; Deposit coverage.

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