ABSTRACT Indonesia Deposit Insurance Corporation (IDIC) was introduced in 2005 to replace implicit or blankeet guarantee system. Currently IDIC uses flat rate insurance premium. Theoretically, the use of flat rate system may induce moral hazard behavior among Indonesian banks, subsidy from low risk banks to high risk banks, and increase insolvency risk for IDIC if bank rush occurs. This paper attempts to calculate fair insurance premium rate (floating rate) as an alternative to flat rate insurance premium. The floating rate can be expected to reduce moral hazard potential and to reflect more realistic economic condition faced by IDIC. We use Credit Risk Value at Risk model with Monte-Carlo simulation to calculate the fair insurance premium. Using 23 public banks in Indonesia, we find several empirical findings. First, default density function is skewed to the right, suggesting high systematic risk in Indonesia. Second, IDIC economic capital seems to be lower than ‘theoretical’ capital calculated using folating rate in surance premium. Third, in line with second finding, the amount of current insurance premium collected by IDIC seems to be lower than the ‘theoretical’ amount calculated using floating rate premium. Our model produces different insurance premium for banks, depending on banks’ risks. Our model also takes account larger exposure to IDIC from larger banks.
Keywords: deposit insurance corporation, flat rate insurance premium, fair rate insurance premium, moral hazard, credit risk JEL Classification: G21