Deposit Insurance and Bank Intermediation in the Long Run

Journal of International Money and Finance, 2010

We ask how deposit insurance systems and ownership of banks affect the degree of market discipline on banks' risk-taking. Market discipline is determined by the extent of explicit deposit insurance, as well as by the credibility of non-insurance of groups of depositors and other creditors. Furthermore, market discipline depends on the ownership structure of banks and the responsiveness of bank managers to market incentives. An expected U-shaped relationship between explicit deposit insurance coverage and banks' risk-taking is influenced by country specific institutional factors, including bank ownership. We analyze specifically how government ownership, foreign ownership and shareholder rights affect the disciplinary effect of partial deposit insurance systems in a cross-section analysis of industrial and emerging market economies, as well as in emerging markets alone. The coverage that maximizes market discipline depends on country-specific characteristics of bank governance. This "risk-minimizing" deposit insurance coverage is compared to the actual coverage in a group of countries in emerging markets in Eastern Europe and Asia. JEL Classification: G21; G28; G32

SSRN Electronic Journal, 2000

Explicit deposit insurance is a two-edged sword with respect to risktaking. High explicit coverage creates incentives to shift risk to a deposit insurance fund or taxpayers; low explicit coverage may be associated with strong implicit insurance reflecting lack of credibility of noninsurance. Institutions that allow banks to fail without serious contagion effects enhance this credibility. Alternative measures of banks' risktaking are used to test the hypothesis expressed as a U-shaped relationship between explicit coverage and risktaking. The hypothesis is strongly supported when the occurrence of banking crises and non-performing loans are proxies for risktaking in a country's banking system. Institutional characteristics affect the relation between explicit coverage and risk-taking. JEL Classification: G21; G28; F43

Journal of Banking & Finance, 2011

This study examines how the introduction of deposit insurance affects depositors and banks, using the deposit-insurance scheme introduced into the Russian banking system as a natural experiment. The fundamental research question is whether the introduction of deposit insurance leads to a more effective banking system as evidenced by increased deposit-taking and decreased reliance upon State-owned banks as custodians of retail deposits. We find that banks entering the new deposit-insurance system increase both their level of retail deposits and their ratios of retail deposits to total assets relative to banks that do not enter the new deposit insurance system. These results hold up in a multivariate panel-data analysis that controls for bank-and time-random effects. The longer a bank has been entered into the deposit insurance system, the greater is its level of deposits and its ratio of deposits to assets. Moreover, this effect is stronger for regional banks and for smaller banks. We also find that implementation of the new deposit-insurance system has the effect of ''leveling the playing field" between State-owned banks and privately owned banks. Finally, we find strong evidence of moral hazard following implementation of deposit insurance in the form of increased bank risk-taking. Financial risk and, to a lesser degree, operating risk increase following implementation.

Review of Pacific Basin Financial Markets and Policies, 2010

This paper models the effect of bank competition and deposit insurance premiums on the spread between lending and deposit rates. In developing economies, low spreads do not always indicate bank efficiency; they may be the result of high risk taking. This paper shows that imposing upper and lower limits on banks' spreads and adjusting deposit insurance premiums when violation of these limits occurs leads to a more stable but relatively large intermediation costs. In developing economies, such an outcome would be considered more desirable because it insulates existing financial intermediaries and investors against macroeconomic disturbances.

Journal of Banking & Finance, 2005

This paper uses a panel database of 251 banks in 36 countries to analyze the impact of bank regulation on bank charter value and risk-taking. After controlling for deposit insurance and for the quality of a country's contracting environment, the results indicate that regulatory ...

Journal of Monetary Economics, 2002

for very helpful comments. We are greatly indebted to Anqing Shi and Tolga Sobac2 for excellent research assistance.

Journal of Money, Credit, and Banking, 2005

Cull, Senbet, and Sorge examine the effect of different insurance leads to financial instability in lax regulatory design features of deposit insurance on long-run financial environments. But in sound regulatory environments, development, defined to include the level of financial deposit insurance does have the desired impact on activity, the stability of the banking sector, and the financial development and growth. quality of resource allocation. Their empirical analysis is Thus countries introducing a deposit insurance scheme guided by recent theories of banking regulation that need to ensure that it is accompanied by a sound employ an agency framework. regulatory framework. Otherwise, the scheme will likely The authors examine the effect of deposit insurance on lead to instability and deter financial development. In the size and volatility of the financial sector in a sample weak regulatory environments, policymakers should at of 58 countries. They find that generous deposit least limit deposit insurance coverage. This paper-a product of Finance, Development Research Group-is part of a larger effort in the group to design financial safety nets for developing countries. The study was funded by the Bank's Research Support Budget under the research project "Deposit Insurance" (RPO 682-90). Copies of this paper are available free from the World Bank,

SSRN Electronic Journal, 2021

Using evidence from Russia, we explore the effect of the introduction of deposit insurance on bank risk. Drawing on variation in the ratio of firm deposits to total household and firm deposits before the announcement of deposit insurance, so as to capture the magnitude of the decrease in market discipline after the introduction of deposit insurance, we demonstrate that larger declines in market discipline generate larger increases in traditional measures of risk. These results hold in a difference-indifference setting in which private domestic banks serve as the treatment group and state and foreign-owned banks, whose deposit insurance regime does not change, serve as a control group.

European Economic Review, 2006

This paper corrects a paper of David Miles, published in the European Economic Review in 1995, reversing some of the conclusions he draws. Solving his model correctly it turns out that, because depositors are unable to monitor the default risk of individual banks, moral hazard gives banks an incentive to increase risky lending. Prudential capital requirements reduce incentives to hold risky loans. r 2004 Elsevier B.V. All rights reserved.

IMF Working Papers, 2005

An endogenous growth model with financial intermediation is used to show how public deposit insurance and weak prudential regulation can lead to banking crises and permanent declines in economic growth. The impact of regulatory forbearance on investment, saving and asset price dynamics under perfect foresight are derived in the model. The assumptions of the theoretical model are based on essential features of the Japanese financial system and its regulation. The model demonstrates how banking and growth crises can evolve under perfect foresight. The dynamics for economic aggregates and asset prices predicted by the model are shown to be generally consistent with the experience of the Japanese economy and financial system through the 1990s. We also test our maintained hypothesis of rational expectations using asset price data for Japan over the 1980s and 1990s. An implication of our analysis is that delaying the resolution of banking crises adversely affects future economic growth.

2019

Using evidence from Russia, we explore the effect of the introduction of deposit insurance on bank risk. Drawing on within-bank variation in the ratio of firm deposits to total household and firm deposits, so as to capture the magnitude of the decrease in market discipline after the introduction of deposit insurance, we demonstrate for private, domestic banks that larger declines in market discipline generate larger increases in traditional measures of risk. These results hold in a difference-in-difference setting in which state and foreign-owned banks, whose deposit insurance regime does not change, serve as a control.

THE INTERNATIONAL JOURNAL OF BUSINESS & MANAGEMENT, 2021

Despite deposit insurance increasingly gaining favour from policy makers, it remains an inconclusive debate with different authors taking different arguments on its effect on bank stability. This paper sets out to establish the link between deposit insurance and bank system stability, with an empirical review on the Kenya banking system. At first, we argued that deposit insurance tends to bring stability in the banking sector by providing assurance to the depositors, thereby reducing the possibilities of bank run. However, such an interaction is only possible where other regulatory framework is available without banking competition. The results do not support our earlier arguments but point that deposit insurance coverage-stability nexus exists in the short run and tends to favour smaller banks. The results however support our second argument that with banking competition, the coverage-stability nexus is diluted as the banks competition increases bank appetite for risky activities regardless of the deposit insurance scheme. We recommend that policy makers should not focus a lot on increasing deposit insurance coverage limit, but rather on other supervisory framework, since the effect of the coverage on stability is felt in the short run.

This paper aims at empirically investigating the role of moral hazard in the e¢ ctivity of deposit insurance in achieving banking stability. If the negative e¤ect of deposit insurance on banking stability is through moral hazard, then deposit insurance will be associated with banking insolvency and credit crunch more than with bank runs. To test this hypothesis, we compute measures of these two types of banking instability. We …nd that deposit insurance per se has no signi…cant e¤ect either on bank insolvency and credit crunch or on bank runs. However, when the deposit insurance is coupled with an increase in credit to private sector, it has a positive and signi…cant e¤ect on bank insolvency and credit crunch but not on bank runs.

AFRE (Accounting and Financial Review), 2019

The Indonesian banking system has implemented a deposit guarantee. Deposit guarantees are carried out in order to provide a sense of security for customers. Moral hazard tends to be higher in the banking industry This study aims to examine the relationship of bank characteristics with market discipline. Bank characteristics include: capital, bank risk, profitability, efficiency and bank size. The population in this study is banks in Indonesia. The sample selection uses a purposive sampling method. The number of samples of 30 banks with peroide 2009-2015. Data analysis techniques used multiple linear regression. The results showed the profitability and size of the bank affect market discipline. Where profitability and bank size have a positive effect on market discipline. This research has implications for the importance of banks in increasing bank assets, especially for private banks.

2008

This dissertation studies a number of topics related to the banking sector regulation. lt focuses on the impact of various types of regulation on the banking system stability and also on the implication of sorne types of regulation for economic dynamic and welfare. In fact, due to numerous market failures present in the banking industry, banks are viewed as fragile. This has led governments to regulate heavily the banking sect or , which is nowadays one of the most regulated industries in the world. This dissertation first reviews the theoretical and the empirical literature On the banking system regulation, then uses the Markov-switching model to assess empirically the impact of regulation on the banking system stability, and finally analyzes the growth and welfare effects of banking regulations, such as asset holding restrictions and capital adequacy requirements. More precisely, the first chapter reviews the work already done on the link between banking regulation and the banking sector stability. It brings together and adds structure to the empirical literature on the link between banking regulation and banking system stability. In addition to clarifying the theoretical underpinnings for studying banking regulation, it points to sever al directions for future empirical research, necessary to fill the gaps in our understanding of the link between banking regulation and stability. Itfinds that although there are many types of banking regulation, studies focus mainly on a group of regulations such as the capital adequacy requirement, the deposit insurance, and the reserve requirement. The theoretical prediction of the effect of almost each type of regulation on the banking sector stability is mixed. The key reason behind this is the fact that there are many types of market failures in the banking industry. Therefore, a regulatory measure can succeed to cure a given market failure but at the same time help to increase the other market failures. In "The Empirics of Banking Regulation", we assess empirically whether banking regulation is effective at preventing banking crises. We use a monthly index of banking system fragility, which captures almost every source of risk in the banking system, to estimate the effect of regulatory measures (entry restriction, reserve requirement, deposit insurance, and capital adequacy requirement) on banking stability in the context of a Markov-switching model. We apply this method to the lndonesian banking system, which has been subject to several regulatory changes over the iv last couple of decades and at the same time has experienced a severe systemic crisis. We draw the following findings from this research: (i) entry restriction reduces crisis duration and also the probability of their occurrence; (ii) larger reserve requirements reduce crisis duration, but increase banking instability; (iii) deposit insurance increases banking system stability and reduces crisis duration; (vi) capital adequacy requirement improves stability and reduces the expected duration of banking crises. Finally, in "The Welfare Cost of Banking Regulation", we are motivated by the fact that the Basel Accords promote the adoption of capital adequacy requirements to increase the banking sector's stability. Unfortunately this type of regulation can hamper economic growth by shifting banks' portfolios from more productive risky investment projects toward less productive but safer projects. We introduce banking regulation in an overlapping-generations model of capital accumulation and studies how it affects economic growth, banking sector stability, and welfare. In this model, a banking crisis is the outcome of a productivity shock, which leads sorne banks to be un able to fulfill their obligations toward lenders. Banking regulation is modeled as a constraint on the maximum share of banks' portfolios that can be allocated to risky assets. This model allows us to evaluate quantitatively the key trade-off inherent to this type of banking regulation, between banking sector stability and economic growth. The model implies an optimal level of regulation which eliminates banking crises. At the same time, regulation is detrimental to growth. We find that the overall effect of the optimallevel of regulation on social welfare is positive when the likelihood of a banking crisis is sufficiently high and economic agents are sufficiently risk-averse. We use the model to evaluate whether the proposed Basel Accord regulation might be welfare-improving, given plausible magnitudes for the likelihood of a crisis and agents' risk aversion.