In this paper, Jan Kregel addresses the following problem.
It’s desirable for obvious reasons for governments to back bank deposits, or at least to guarantee some minimum amount of those deposits. Unfortunately, this gives rise to moral hazard: it induces banks to behave more recklessly. And second, that guarantee inevitably involves subsidising what is in effect commerce.
That is, if you invest direct in the stock exchange, a buy to let property or whatever, there are no government guarantees for you in case your investment goes wrong, and rightly so. On the other hand, if you place money in a bank, and the bank makes a series of bad loans or investments in firms large or small or in mortgages and it goes wrong, the taxpayer comes riding to your rescue.
As Kregel puts it, “It would thus seem impossible to design a truly fair deposit insurance scheme that eliminates the inherent moral hazard….”
Well actually Positive Money, Prof. Richard Werner and the New Economics Foundation solved that one some time ago. See here.
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