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Market discipline and financial safety net design

  • Demirguc-Kunt, Asl1
  • Huizinga, Harry

There has been little empirical work on the effectiveness of safety nets designed for banks, for lack of data on safety net design across countries. The authors examine cross-country data on bank-level interest expense and deposit growth for evidence of market discipline in individual countries. In addition, using cross-country information on deposit insurance systems, they investigate the impact of explicit deposit insurance (and its key features) on bank interest rates and market discipline. They find that: 1) Many countries retain some degree of market discipline, regardless of the type of safety net. 2) The existence of explicit deposit insurance lowers banks'interest expenses and makes interest payments less sensitive to bank risk factors, especially bank liquidity. 3) Higher explicit coverage, broader coverage, and the existence of an earmarked insurance fund increase required-deposit rates and reduce market discipline. 4) Private (especially joint) management of insurance schemes lowers deposit rates and improves market discipline.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2183.

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Date of creation: 30 Sep 1999
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Handle: RePEc:wbk:wbrwps:2183
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  1. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
  2. Gary Gorton & Richard Rosen, 1992. "Corporate control, portfolio choice, and the decline of banking," Finance and Economics Discussion Series 215, Board of Governors of the Federal Reserve System (U.S.).
  3. G. G. Garcia, 1999. "Deposit Insurance; A Survey of Actual and Best Practices," IMF Working Papers 99/54, International Monetary Fund.
  4. Park, Sangkyun & Peristiani, Stavros, 1998. "Market Discipline by Thrift Depositors," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 347-64, August.
  5. Asli Demirgüç-Kunt & Enrica Detragiache, 1998. "The Determinants of Banking Crises in Developing and Developed Countries," IMF Staff Papers, Palgrave Macmillan, vol. 45(1), pages 81-109, March.
  6. Cook, Douglas O & Spellman, Lewis J, 1994. "Repudiation Risk and Restitution Costs: Toward Understanding Premiums on Insured Deposits," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(3), pages 439-59, August.
  7. Park, Sangkyun, 1995. "Market discipline by depositors: Evidence from reduced-form equations," The Quarterly Review of Economics and Finance, Elsevier, vol. 35(35), pages 497-514.
  8. Ellis, David M. & Flannery, Mark J., 1992. "Does the debt market assess large banks, risk? : Time series evidence from money center CDs," Journal of Monetary Economics, Elsevier, vol. 30(3), pages 481-502, December.
  9. Flannery, Mark J, 1998. "Using Market Information in Prudential Bank Supervision: A Review of the U.S. Empirical Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 273-305, August.
  10. Avery, Robert B & Belton, Terrence M & Goldberg, Michael A, 1988. "Market Discipline in Regulating Bank Risk: New Evidence from the Capital Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(4), pages 597-610, November.
  11. Gorton, Gary & Santomero, Anthony M, 1990. "Market Discipline and Bank Subordinated Debt," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 22(1), pages 119-28, February.
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