Sensitivity of Depositors to Risk of Small Banks under Deposit Insurance Regime: Evidence from Indonesia

Several studies have revealed the sensitivity of depositor to the risk magnitude in various types of banks, which operate under the Deposit Insurance Regime. However, the earlier studies have never specifically investigated the Market Discipline issue in small bank industry in the emerging economy. Small bank banks have limited liquidity capacity and service networks, making them vulnerable to the impact of the economic crisis in an economy. Consumers of such banks are generally interested in saving funds in these banks because the interest rates on deposits are generally higher than interest rates in low-risk banks, especially in developing countries. We conduct this study to fill in the literature gap, by investigating how the market reacts to the risk level of 28 small banks in Indonesia. We conduct analysis using the Reduced Form Equation. In this approach, the first model is to measure the risk of each bank using the Probit equation. The second model, Multiple Regression Equation, reveal how sensitive depositors to risk of the small banks.