Risk-based capital standards, deposit insurance, and procyclicality

This article shows that risk-based deposit insurance premiums generate smaller procyclical effects than do risk-based capital requirements. Thus, Basel II's procyclical impact can be reduced by integrating risk-based deposit insurance. If deposit insurance is structured as a moving average of contracts, its procyclical effects can be decreased further. Empirical illustrations of this are presented for 42 banks over the period 1987 to 1996. The results confirm that lengthening the contracts' maturities intertemporally smooths premiums but raises the average premium level needed to compensate the insurer for greater systematic risk. The distribution of risk-based premiums across banks is skewed.