Deposit insurance and bank dividend policy

Abstract

This study investigates whether deposit insurance affects bank payout policy. To overcome identification concerns, we use the US Emergency Economic Stabilization Act of 2008, which increased the maximum limit of deposit insurance coverage, leading to significant changes in the proportion of insured deposits to assets of some banks, while leaving others relatively unaffected. In line with the view that dividends convey information regarding financial health, we find that banks, which experience a substantial increase in insured deposits reduce dividends relative to others with a smaller increase in insured deposits. An extensive battery of further tests confirm that our results are not driven by events (such as capital injections due to participation in the Trouble Asset Relief Program, peer effects, state tax changes, deposit insurance pricing changes) that took place around the time of the increase in the maximum limit of deposit insurance coverage. Overall, the results of our empirical analysis suggest that banks holding fewer uninsured deposits pay less dividends.