The implied reserves of the Bank Insurance Fund

Option models of deposit insurance pricing view assessment rates as put option premiums. However, such models ignore the risk of guaranty fund default. This paper attempts to link risk-based premiums with guaranty fund reserves in a partial equilibrium setting, by employing a methodology based on options with credit risk. The value of full insurance per coverage period is expressed as a standard options premium and is decomposed into two parts. The explicit part is due to the available assets (reserves) of the guaranty fund, while the implicit part comes from federal support, contingent on the adequacy of reserves at the end of the coverage period. Implied reserves are derived under an exogenous insurance coverage rate as a policy parameter. The method is illustrated on a sample of 40 large bank holding companies and an extension to the case of several insured banks is provided. (C) 2003 Elsevier B.V. All rights reserved.