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The Impact of Explicit Deposit Insurance on Market Discipline

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  • Vasso Ioannidou
  • Jan de Dreu

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 Netherlands Central Bank, Research Department in its series DNB Working Papers with number 089.

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Date of creation: Feb 2006
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Handle: RePEc:dnb:dnbwpp:089

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Keywords: Market Discipline; Deposit Insurance; Deposit Insurance Coverage.;

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References

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  1. Timothy H. Hannan & Gerald A. Hanweck, 1986. "Bank insolvency risk and the market for large certificates of deposit," Working Papers in Banking, Finance and Microeconomics 86-1, Board of Governors of the Federal Reserve System (U.S.).
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Citations

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Cited by:
  1. Disli, Mustafa & Schoors, Koen & Meir, Jos, 2013. "Political connections and depositor discipline," Journal of Financial Stability, Elsevier, vol. 9(4), pages 804-819.
  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. 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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