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The importance of deposit insurance credibility

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  • Diana Bonfim
  • João A. C. Santos

Abstract

The success of deposit insurance arrangements at eliminating bank runs is likely closely tied to their credibility. We investigate this hypothesis building on two episodes which tested the insurance protection offered by the Portuguese arrangement in the midst of the country’s sovereign debt crisis. Our results show that Portuguese depositors responded to foreign banks’ decision to convert their subsidiaries into branches by relocating their deposits into the latter. We find a similar response following the announcement that insured depositors in Cyprus would lose part of their savings. On both instances responses are concentrated on household deposits. Given that foreign banks’ branches offer the insurance protection of these banks’ home countries, rather than that granted by their host country arrangement, our findings confirm that the credibility of the deposit insurance arrangement is critical for the protection it offers banks against the risk of depositor runs. These results show that sovereign-bank links can be detrimental to financial stability through a novel channel: the credibility of deposit insurance.

Suggested Citation

  • Diana Bonfim & João A. C. Santos, 2020. "The importance of deposit insurance credibility," Working Papers w202011, Banco de Portugal, Economics and Research Department.
  • Handle: RePEc:ptu:wpaper:w202011
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    Cited by:

    1. Berger, Allen N. & Demirgüç-Kunt, Asli, 2021. "Banking research in the time of COVID-19," Journal of Financial Stability, Elsevier, vol. 57(C).
    2. Toni Ahnert & Christoph Bertsch, 2022. "A Wake-Up Call Theory of Contagion [Asymmetric business cycles: theory and time-series evidence]," Review of Finance, European Finance Association, vol. 26(4), pages 829-854.
    3. Huertas, Thomas F., 2021. "Reset required: The euro area crisis management and deposit insurance framework," SAFE White Paper Series 85, Leibniz Institute for Financial Research SAFE.
    4. Eule, Joachim & Kastelein, Wieger & Sala, Edoardo, 2022. "Protecting depositors and saving money: Why deposit guarantee schemes in the EU should be able to support transfers of assets and liabilities when a bank fails," Occasional Paper Series 308, European Central Bank.
    5. Hasan, Iftekhar & Liu, Liuling & Saunders, Anthony & Zhang, Gaiyan, 2022. "Explicit deposit insurance design: International effects on bank lending during the global financial crisis✰," Journal of Financial Intermediation, Elsevier, vol. 51(C).

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    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • 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

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