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Banking instability and deposit insurance: The role of moral hazard

Author

Listed:
  • Harold Ngalawa

    (University of KwaZulu-Natal)

  • Fulbert Tchana Tchana

    (The World Bank)

  • Nicola Viegi

    (University of Pretoria)

Abstract

The primary objective of this paper is to investigate the impact of moral hazard on the effectiveness of deposit insurance in achieving banking stability. If moral hazard explains banking instability arising from the adoption of deposit insurance, then deposit insurance will be associated with bank insolvency more than with bank runs. To test the hypothesis, we develop a new empirical framework distinguishing between banking instability initiated by panic withdrawals of deposits, and banking instability initiated by the insolvency problem of banks. Using a dataset covering 118 countries over the period 1980-2004, we find that deposit insurance per se has no significant effect either on bank insolvency or on bank runs. However, interacting deposit insurance with credit to the private sector, we observe a positive and significant effect on bank insolvency and bank runs, suggesting that moral hazard outweighs the positive effect of deposit insurance on banking stability.

Suggested Citation

  • Harold Ngalawa & Fulbert Tchana Tchana & Nicola Viegi, 2016. "Banking instability and deposit insurance: The role of moral hazard," Journal of Applied Economics, Universidad del CEMA, vol. 19, pages 323-350, November.
  • Handle: RePEc:cem:jaecon:v:19:y:2016:n:2:p:323-350
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    References listed on IDEAS

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    Cited by:

    1. Janda, Karel & Kravtsov, Oleg, 2017. "Micro-Level Evidences of Moral Hazard in the European Financial Institutions," MPRA Paper 77233, University Library of Munich, Germany.
    2. Raheel Mumtaz & Imran Abbas Jadoon, 2018. "Effect of explicit deposit insurance premium on the moral hazard of banks’ risk-taking: Around the globe," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 5(02), pages 1-24, June.

    More about this item

    Keywords

    banking crises; deposit insurance; moral hazard;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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