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Professor Chong Huang
Associate Professor of Finance
The Paul Merage School of Business
University of California, Irvine

Banking crises pose significant threats to our economy, leading to the implementation of policy measures such as deposit insurance and liquidity injection to strengthen financial stability and optimize resource allocation efficiency. This paper investigates the dynamic interplay between deposit insurance and liquidity injection. Facing uncertainty regarding bank health and depositor liquidity shocks, policymakers decide liquidity injection based on early withdrawals. While higher deposit insurance coverage can mitigate panic runs, it may undermine the effectiveness of liquidity injections. We demonstrate that liquidity injection overshadows deposit insurance. Consequently, the optimal policy portfolio entails zero deposit insurance, enhancing resource allocation efficiency but allowing more panic runs.