This paper argues that although financial consolidation creates some danger
s because it is leading to larger institutions who might expose the US fina
ncial system to increased systemic risk, these dangers can be handled by vi
gilant supervision and a government safety net with an appropriate amount o
f constructive ambiguity. Financial consolidation also opens up opportuniti
es to dramatically reduce the scope of deposit insurance and limit it to na
rrow bank accounts, thus substantially reducing the moral hazard created by
the government safety net. Reducing the scope of deposit insurance, howeve
r, does not eliminate the need for a government safety net, and thus there
is still a strong need for adequate prudential supervision of the financial
system. Moving to a world in which we have larger, nationwide, diversified
financial institutions and in which deposit insurance plays a very limited
role, should improve the efficiency of the financial system. However, it i
s no panacea: the job of financial regulators and supervisors will continue
to be highly challenging in the future. (C) 1999 Elsevier Science B.V. All
rights reserved.