A Theoretical Analysis of Depositor Discipline in Banking with Reference to India

Abstract

In recent years, there is increasing emphasis on depositor discipline as a mechanism to augment Government oversight (discipline) of the financial sector, specifically depository institutions. Despite the abundance of empirical research on this score, limited theoretical analysis has been forthcoming on the issue. The paper develops a model that incorporates the twin features of depositor discipline and regulatory structure and examines the effects of several parameters on the optimal decision-making process of the bank. These findings are related to the on-going process of economic reforms in India.