Abstract
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) forced uninsured creditors such as jumbo-CD holders to bear more of the losses from bank failures. Because no other federal laws affecting loss exposure took effect in the surrounding years, the Act offers a natural experiment for assessing the supervisory returns from greater reliance on debt markets to police bank risk. Accordingly, we examine the sensitivity of jumbo-CD yields and run-offs to risk before and after FDICIA as well as the implied impact of any risk penalties on bank profitability. The evidence indicates that yields and run-offs were risk sensitive in both periods, but that this sensitivity was always economically small and, more importantly, was not significantly higher after the Act. These findings suggest that raising the deposit-insurance ceiling would not - at least in the current institutional and economic environment - exacerbate moral hazard. More importantly, they also suggest that operationalizing debt-market discipline as pillar of bank supervision could prove more difficult than previously thought.
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