Regulatory Forbearance and Deposit Insurance Pricing: A Comment on the Ronn-Verma Option-Based Model

Abstract

This paper examines the relationship between regulatory forbearance and the pricing of deposit insurance for listed commercial banks in Taiwan. After first reviewing the literature regarding the application of the option pricing models to assess the risk-based deposit insurance premiums, we then apply the Ronn-Verma option pricing model to empirically examine the effect of alternative schemes of regulatory forbearance on the deposit insurance premiums of Taiwan's listed commercial banks. We find that the estimated deposit insurance premiums, in addition to increasing with time, are also increasing with the degree of regulatory forbearance, and different degrees of regulatory forbearance will lead to different inferences regarding over- or under-charging. Thus, we conclude that the extent to which the deposit insurance agency under- or over-prices the deposit insurance premiums will depend on the degree of regulatory forbearance. If there is a high degree of regulatory forbearance, the risk that insured institutions bear will be higher, and consequently a higher premium will be charged. However, when the degree of regulatory forbearance is lower, the risk that the insured institutions bear will be lower and hence lower premiums will be assessed.