Bank Deposit Insurance, Moral Hazard and Market Discipline: Evidence from Central and Eastern Europe

Abstract

There is a considerable debate on the role played by deposit insurance on market discipline in the banking industry. Using data for 203 banks across 10 Central and Eastern European countries, this paper empirically analyzes the implications of the implementation of explicit deposit insurance schemes for bank risk taking and market discipline. We show that the introduction of explicit deposit insurance in the 90’s has lead to higher risk-taking incentives. However, we also show that explicit deposit insurance has strengthened market discipline. Moreover, we find that bank ownership (foreign vs. domestic), institutional and legal factors, and resolution strategies adopted when the country has experienced banking crises impact bank risk and the effectiveness of market discipline.