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Market discipline and financial safety net design

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  • Demirguc-Kunt, Asl1
  • Huizinga, Harry

Abstract

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.

Suggested Citation

  • Demirguc-Kunt, Asl1 & Huizinga, Harry, 1999. "Market discipline and financial safety net design," Policy Research Working Paper Series 2183, The World Bank.
  • Handle: RePEc:wbk:wbrwps:2183
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    References listed on IDEAS

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    1. Gorton, Gary & Santomero, Anthony M, 1990. "Market Discipline and Bank Subordinated Debt," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 22(1), pages 119-128, February.
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    3. Gorton, Gary & Rosen, Richard, 1995. " Corporate Control, Portfolio Choice, and the Decline of Banking," Journal of Finance, American Finance Association, vol. 50(5), pages 1377-1420, December.
    4. 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.
    5. 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.
    6. 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.
    7. G. G. Garcia, 1999. "Deposit Insurance; A Survey of Actual and Best Practices," IMF Working Papers 99/54, International Monetary Fund.
    8. 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 439-459, August.
    9. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-838, May.
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    11. 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.
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    More about this item

    Keywords

    Financial Intermediation; Banks&Banking Reform; Insurance&Risk Mitigation; Payment Systems&Infrastructure; Insurance Law; Banks&Banking Reform; Financial Intermediation; Insurance&Risk Mitigation; Insurance Law; Financial Crisis Management&Restructuring;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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