Market Discipline and Deposit Insurance: Evidence from Some Middle Eastern Banks

Financial development, which involves the establishment and expansion of institutions, instruments and markets, plays an important role in economic growth given that they can ameliorate information and transaction costs, facilitate a more efficient mobilization of savings, spread risk and provide liquidity. Moreover, given the high costs of banking crises, regulators always seek the means that promote greater levels of prudence in banks’ behavior. Indeed, this can be done by relying on certain regulatory actions (supervision and regulations) and on market discipline. In turn, market discipline relies on private sector agents (equity holders and debt holders) to produce information that assists bank supervisors in recognizing potential banking problems and in implementing remedial measures. The primary objective of this research is to provide answers to two questions. First, do depositors discipline Jordanian, Kuwaiti, Omani, and Saudi banks? Second, does the deposit insurance design have any bearing on market discipline – given the fact that Kuwaiti and Saudi deposits are 100 percent insured explicitly and implicitly respectively, while Jordanian and Omani deposits are insured up to $14,000 and $50,000 respectively.Based on a sample of listed Jordanian, Kuwaiti, Omani, and Saudi banks during the time period 1997 – 2006, the overall results clearly indicate the absence of market discipline in Kuwait, Oman, and Saudi Arabia. In other words, market discipline is at work only in Jordan.