Working Paper: CEPR ID: DP2311
Authors: Asli Demirgüç-Kunt; Harry Huizinga
Abstract: An important question is whether the financial safety net reduces market discipline on bank risk taking. For countries with varying deposit insurance schemes, we find that deposit rates continue to reflect bank riskiness. Cross-country evidence suggests that explicit deposit insurance reduces required deposit interest rates at a cost of reduced market discipline. Internationally, deposit insurance schemes vary widely in their coverage, funding, and management. Hence, there are widely differing views on how deposit insurance should optimally be structured. To inform this debate, we use a newly constructed data set of deposit insurance design features to examine how different design features affect deposit interest rates and market discipline.
Keywords: market discipline; deposit insurance
JEL Codes: E43; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| explicit deposit insurance (G28) | lower interest expenses for banks (G21) |
| explicit deposit insurance (G28) | diminished market discipline (G18) |
| increased explicit coverage of deposit insurance (G28) | decreased market discipline (G18) |
| reduced sensitivity of interest rates to bank risk factors (G21) | less vigilant monitoring of banks (G28) |
| explicit deposit insurance (G28) | increased likelihood of moral hazard in the banking system (F65) |