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The Impact of Explicit Deposit Insurance on Market Discipline

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  • Ioannidou, V.
  • Dreu, J. de

    (Tilburg University, Center for Economic Research)

Abstract

This paper studies the impact of explicit deposit insurance on market discipline in a framework that resembles a natural experiment.We improve upon previous studies by exploiting a unique combination of country-specific circumstances, design features, and data availability that allows us to distinguish between demand and supply effects.We show that deposit insurance causes a significant reduction in market discipline.We also show that the effect of deposit insurance depends on the coverage rate.When the coverage rate is more than 60 percent, market discipline is significantly reduced and it is completely eliminated when the coverage rate reaches 100 percent.Our results also suggest that most market discipline comes from large depositors and that the introduction of deposit insurance affected mainly those who were already active in imposing discipline.Our findings emphasize the need for binding coverage limits per depositor, high degrees of co-insurance, and "tailor made" deposit insurance systems that preserve the incentives of a critical mass of depositors that are willing and able to perform this function.

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Bibliographic Info

Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2006-5.

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Date of creation: 2006
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Handle: RePEc:dgr:kubcen:20065

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Web page: http://center.uvt.nl

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Keywords: market discipline; deposit insurance; deposit insurance coverage;

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  1. Flannery, Mark J, 1982. "Retail Bank Deposits as Quasi-Fixed Factors of Production," American Economic Review, American Economic Association, vol. 72(3), pages 527-36, June.
  2. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  3. Randall S. Kroszner & Philip E. Strahan, 2001. "Obstacles to Optimal Policy: The Interplay of Politics and Economics in Shaping Bank Supervision and Regulation Reforms," NBER Chapters, in: Prudential Supervision: What Works and What Doesn't, pages 233-272 National Bureau of Economic Research, Inc.
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  7. Laeven, Luc, 2004. "The political economy of deposit insurance," Policy Research Working Paper Series 3247, The World Bank.
  8. Park, Sangkyun & Peristiani, Stavros, 1998. "Market Discipline by Thrift Depositors," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 347-64, August.
  9. Maria Soledad Martinez Peria, 2001. "Do Depositors Punish Banks for Bad Behavior? Market Discipline, Deposit Insurance, and Banking Crises," Journal of Finance, American Finance Association, vol. 56(3), pages 1029-1051, 06.
  10. Martinez Peria, Maria Soledad & Schmukler, Sergio L., 1999. "Do depositors punish banks for"bad"behavior? : market discipline in Argentina, Chile, and Mexico," Policy Research Working Paper Series 2058, The World Bank.
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  12. Park, Sangkyun, 1995. "Market discipline by depositors: Evidence from reduced-form equations," The Quarterly Review of Economics and Finance, Elsevier, vol. 35(35), pages 497-514.
  13. Cook, Douglas O & Spellman, Lewis J, 1994. "Repudiation Risk and Restitution Costs: Toward Understanding Premiums on Insured Deposits," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(3), pages 439-59, August.
  14. Cook, Douglas O. & Spellman, Lewis J., 1991. "Federal financial guarantees and the occasional market pricing of default risk: Evidence from insured deposits," Journal of Banking & Finance, Elsevier, vol. 15(6), pages 1113-1130, December.
  15. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
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  17. Demirguc-Kunt, Asli & Huizinga, Harry, 2004. "Market discipline and deposit insurance," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 375-399, March.
  18. Calomiris, Charles W., 1999. "Building an incentive-compatible safety net," Journal of Banking & Finance, Elsevier, vol. 23(10), pages 1499-1519, October.
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Citations

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Cited by:
  1. Philip Maymin & Zakhar Maymin, 2012. "Any regulation of risk increases risk," Financial Markets and Portfolio Management, Springer, vol. 26(3), pages 299-313, September.
  2. Ioannidou, V. & Penas, M.F., 2008. "Deposit Insurance and Bank Risk-Taking: Evidence from Internal Loan Ratings," Discussion Paper 2008-022, Tilburg University, Tilburg Law and Economic Center.
  3. A. F. Aysan & M. Disli & H. Ozturk & I. M. Turhan, 2013. "Are Islamic Banks Subject to Depositor Discipline?," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 13/871, Ghent University, Faculty of Economics and Business Administration.
  4. Disli, Mustafa & Schoors , Koen & Meir, Jos, 2013. "Political connections and depositor discipline," BOFIT Discussion Papers 6/2013, Bank of Finland, Institute for Economies in Transition.
  5. Günther, Susanne, 2014. "Die Vermeidung von Bank Runs und der Erhalt von Marktdisziplin: Das Dilemma der Bankenregulierung?," Arbeitspapiere 142, Westfälsche Wilhelms-Universität Münster (WWU), Institut für Genossenschaftswesen.
  6. Peresetsky, A.A. & Karminsky, A.M. & Golovan, S.V., 2007. "Russian banks´ private deposit interest rates and market discipline," BOFIT Discussion Papers 2/2007, Bank of Finland, Institute for Economies in Transition.

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