Bank Capital, Liquidity Creation and Deposit Insurance

Abstract

This paper examines how the introduction of deposit insurance influences the relationship between bank capital and liquidity creation. As discussed by Berger and Bouwman (2009), there are two competing hypotheses on this relationship which can be influenced by the presence of deposit insurance. The introduction of a deposit insurance scheme in an emerging market, Russia, provides a natural experiment to empirically investigate this issue. We use the difference-in-difference approach on a large dataset of all Russian banks. Our findings suggest that the introduction of the deposit insurance scheme does not have an impact on the relationship between capital and liquidity creation for all banks. However, it influences this relationship in the banks that are most affected by this scheme. For these banks, deposit insurance reduces the impact of capital on liquidity creation. This finding has important policy implications as it suggests that deposit insurance and capital requirements should not be considered separately by bank regulators.