Chapter 26 - The Impact of Explicit Deposit Insurance on Market Discipline

Abstract

This chapter studies how the introduction of an explicit deposit insurance scheme in Bolivia in 2001 affected depositors’ incentives to monitor and discipline their banks for risk-taking. We find that after the introduction of the explicit deposit insurance scheme, the sensitivity of deposit interest rates and volumes to bank risk is reduced significantly, consistent with a reduction in depositor discipline. This effect operates mainly though large depositors—the class of depositors who were sensitive to their banks’ risk in the first place. We also find that as the decrease in depositor discipline grows larger, the insurance coverage rate also grows larger. Deposit interest rates and volumes become almost completely insensitive to bank risk when the insurance coverage is higher than 60%. All in all, our results provide support for deposit insurance schemes with explicit deposit insurance limits per depositor.