Banking with Uninsured Liabilities: Spain in the 1860s

Moro, Alessio;Nuno, Galo

2014-01-01

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Abstract

This paper studies the macroeconomic e§ects of banks operating with (and without) deposit insurance. We Örst document a natural experiment regarding the e§ect of a Önancial crisis on a banking system where no public intervention (liquidity provision, deposit insurance or bail-outs) takes place. This is the case of Spain in the 1864-1866, in which a Önancial crisis had the e§ect of liquidating almost half of the banking system. This, in turn, induced a large credit contraction and a severe recession. Next, we analyze which would have been the effect of the crisis provided that a centralised deposit insurance scheme had been in place. To this end we calibrate a general equilibrium model with banks that broadly reproduces the structure of the Spanish economy at the time and evaluate the counterfactual of introducing deposit insurance. Regulation increases the steady-state level of output, consumption, capital and employment while it reduces the volatility of these variables in the dynamic equilibrium. We also Önd that an economy with deposit insurance enjoys substantial welfare gains with respect to one that displays an uninsured banking sector.