Do Deposit Insurance Systems Promote Banking Stability?

Nafis Alam,Muhammad Ishaq Bhatti,Ganesh Sivarajah

doi:10.3390/ijfs9030052

Nafis Alam, Muhammad Ishaq Bhatti + Show 1 more

Open Access

https://doi.org/10.3390/ijfs9030052

Copy DOI

Abstract

During the global financial crisis (GFC), regulators and policymakers turned to deposit insurers, along with monetary and fiscal measures, to help restore market confidence and promote financial stability. These events have focused attention on the role of deposit insurers and their role in the banking system. Recent literature reveals that during the GFC, deposit insurance maintained banking stability and successfully prevented customers doing ‘runs’ on the banks. The objective of this paper is to examine the deposit insurance system’s coverage limits and the impact on banking stability, in the context of a jurisdiction’s economic and institutional environment. Our model examines 61 jurisdictions in Asia and Europe with explicit deposit insurance systems, covering the pre- and post-GFC period between 2004 and 2014. We also examine subsets to investigate the effects of the region by comparing Asia and Europe, as well as a subset using the date of establishment of the deposit insurance system to understand if maturity matters. The results indicate that deposit insurance systems, and specifically deposit insurance coverage levels, have both positive and negative effects on banking stability. We find significant associations with certain economic and institutional factors; however, there are differences between the models we ran. These can be ascribed to regional factors and the date of when a deposit insurance system was established.

Highlights

This paper aims to investigate the relationship between the level of deposit insurance coverage and banking stability in Asia and Europe by covering a data set from 61 jurisdictions for the period 2004–2014
Deposit insurance systems were implemented in more jurisdictions following the global financial crisis as governments and policymakers had to find ways to maintain financial stability and resolve this problem urgently
During the global financial crisis (GFC), a policy response to financial instability was to expand deposit insurance coverage, with temporary blanket guarantees on all deposits becoming commonplace, while jurisdictions without existing deposit insurance systems had to move quickly to set up coverage (Anginer et al 2014)

Summary

Introduction

Kozińska (2021) highlighted the importance of deposit insurance which grew from obscurity following the 2008/9 global financial crisis (GFC). During this period, retail depositors in Greece, Iceland, Cyprus, and the United Kingdom discovered that their banks were in distress and facing huge governance and financial discrepancy issues. The potential failure of large financial institutions was a threat to the whole economic system, and governments including regulators, had to take extraordinary measures to restore financial stability during the GFC (Al Rahahleh and Bhatti 2017; Baghdadi et al.2018; Azmat et al 2020). The call for better deposit insurance gained more prominence during the recent COVID-19 pandemic as depositors demand deposit insurers in meeting payout obligations in case banking systems fail to cope with prevailing economic conditions. Sabourin (2020) noted that flexibility to access or call upon a wide and varied range of stabilization tools such as deposit insurance is very important to quickly meet the challenges presented by fast changing circumstances

Objectives

Results

Conclusion