Financial Safety Nets, Bank Risk and Depositor Behaviour in Central and Eastern Europe

We studied expansions in financial safety nets and their relation to bank risk and depositor behaviour in Central and Eastern Europe, using time-varying regulatory data. In general, we find that stronger deposit insurance and state aid granted to banks are linked with both bank risk and depositor behaviour. However, these relations critically depend on whether safety net instruments are used separately or simultaneously. When deposit insurance is strengthened or state aid is granted, we confirm the standard moral hazard behaviour of banks visible in higher bank risk. In parallel, we observe more elevated deposit growth, implying lower market discipline. Conversely, when there is a simultaneous increase in deposit insurance and granting of state aid, our findings reverse. This indicates that strong policy interventions may have different links to bank risk and depositor trust than single, weaker actions. At the same time, we confirm earlier findings from the literature that expansions of financial safety net are not linked with all types of bank risk and may be associated with lagged effects.