Optimal regulation of a fully insured deposit banking system

We analyze risk sensitive incentive compatible deposit insurance in the pre sence of private information when the market value of deposit insurance can be determined using Merton's (1977, 3-11) formula. We show that, under the assumption that transferring funds from taxpayers to financial institution s has a social cost, the optimal regulation combines different levels of ca pital requirements combined with decreasing premia on deposit insurance. On the other hand, it is never efficient to require the banks to hold riskles s assets. Finally, chartering banks is necessary in order to decrease the c ost of asymmetric information.