Banks have access to funds at rates lower than those paid by uninsured financial institutions. Moreover, it is clear from the worst period of the bank failures of the 1980s that even the most conspicuously unsound banks have access to deposits at rates only marginally greater than rates offered by sound banks. The second component of the deposit insurance subsidy is lower capital than would otherwise be required by the marketplace. A lower capital requirement means a bank has the opportunity to be more leveraged and take on more risk. The market price for this subsidy would be very high, possibly infinite.
Moral hazard is the tendency of the insured to be indifferent to risks against which it is insured.
To protect themselves from the potential consequences of moral hazard, insurers impose limitations that directly or indirectly subject the insured to some of the risk. With virtually 100 percent deposit insurance, depositors are indifferent to the condition of the banks that hold their deposits. Rather, their incentive is to identify the bank paying the highest rates. To assess the bankers' price for this subsidy we have to examine the supervision and regulation burden imposed upon them in this alleged Faustian bargain. Supervision and regulation of banks covers two broad areas.