Deposit Insurance and the 2008-2009 Global Financial Crisis

Abstract

Our paper revisits benefits and costs of explicit deposit insurance and examines the role of deposit insurance during the 2008-2009 financial crisis period. The crisis provides an ideal setting to test whether DI achieved its intended purpose. We investigate whether DI influences banks’ ability to retain deposits, interbank market liquidity, loans granted to the industrial sectors, and fund flows across countries, in addition to the risk taking behavior, the usual focus of most studies in the literature. We find supportive evidence that deposit insurance help banks retain deposits and alleviate declines in the amount of corporate loans. It also has positive externalities in the sense that corporate loan spreads have a smaller increase when the country has explicit deposit insurance. Finally, deposit insurance mitigates the global bank’s ‘flight-to-home’ effect. The paper goes beyond examining the mere presence of a deposit insurance and investigates the role of specific deposit insurance designs, including whether DI has risk-based insurance premium, coinsurance, full coverage, ‘risk-minimizing’ arrangements, dual funding sources, and was established by government or not. Indeed, the effects are more pronounced for certain design features.