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This paper formalizes the notion that a bank regulator may pursue self interest rather than social welfare, and examines the implications of this for deposit insurance and regulatory reform in banking. We model the pursuit of self interest by introducing uncertainty about the regulator's ability to monitor the bank's asset choice. This uncertainty creates a desire for the regulator to acquire a reputation as a capable monitor, and this desire distorts his bank closure policy and inflates the liability of the deposit-insurance fund. We use this perspective on bank regulation to generate numerous policy prescriptions about banking reform.

The thrift and banking crises of the last decade have led to a surge in vitriol concerning the process of regulation. The need for reform is thus acknowledged by many, but despite limited progress made by the Federal Deposit Insurance Corporation Improvement Act (FIDICIA) of 1991, there seems …