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to be considered in designing the system. Overgenerous deposit insurance can lead to financial instability seriously affect the market discipline. For example I am using S&L crisis to explain an over generous deposit insurance can cause financial instability. Savings and Loan are mutual association which offered deposits and offered cheap finance to purchase homes. The financial deregulation occurred during 1980's in United States. The Federal Deposit Insurance Corporation was established in 1934 to increase the financial stability this provision of deposit insurance contributed to financial stability from 1934-1980, it covered deposits up to $40,000. There was number of bank failures from the period between 1985-1992 about 750 financial intermediaries collapsed during this period. Financial innovation, increase in competition and over generous explicit deposit insurance system was the reason for the crisis. The FDIC insured $100,000 of the depositors accounts at that time. S&L's took excessive risk, offering high risk loans and deposits . By doing this S&L were gaining more profits and the risk of loss was transferred to FDIC. The overgenerous deposit insurance system did not encourage the depositors to monitor the banks activity and on the other hand the banks also to advantage of this an engaged in excessive risks. This crisis affected the market discipline and caused instability in USA. Sir Callum Mc McCarthy chairman of FSA commented on US saving and loan problems, it was quite clear that 100% coverage resulted in some distortion of behaviour and some serious moral hazard (HM treasury report).#p#分页标题#e#

One method used to measure the coverage limit is by using the countries gross domestic product per capita. The economic studies show that the bank crisis increases with the ratio of coverage to per capita GDP increase. when the saving and loan crisis happened the coverage was 9 times per capita.

The IMF guide lines, recommend limiting the coverage to one or two times GDP. United Kingdom had coverage less than 2 times the per capita GDP at the time of crisis. The new coverage is close to 2 times per capita. The scheme is in line with IMF guide line any further increase of 50,000 or 100,000 will encourage the moral hazard activity. The European commission deposit guarantee schemes directive requires a minimum guarantee of 20,000 for the EU member state. A Further increase in the scheme would significantly increase the costs to the institutions, an increase in compensation can cause moral hazards. The HM treasury report shows the FSA has a plan of increasing the compensation, which received the information from financial service consumer panel. An increase to 100,000 will significantly affect the market discipline and will give rise to moral hazard problems. An increase in compensation limit to 100,000 will be over 5 times per capita GDP for the UK. An Empirical studies Patricia A. McCoy, 2007, show countries with coverage of over 4 times per capita GDP are likely to experience 3 time crises more than the other countries