Do Depositors Punish Banks for Bad Behavior? Market Discipline in Argentina, Chile, and Mexico

Abstract

This paper examines the existence of market discipline in the banking industries of Argentina, Chile, and Mexico during the 1980s and 1990s. Using a bank panel data set, we test for the presence of market discipline by studying whether depositors punish risky banks by withdrawing their deposits. We find that across countries and across deposit insurance schemes, market discipline exists even among small, insured depositors. Standardized coefficients and variance decomposition of deposits indicate that bank fundamentals are at least as important as other factors affecting deposits. GMM estimations confirm that the results are robust to the potential endogeneity of bank fundamentals.