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

Abstract

A study of the banking industries of Argentina, Chile, and Mexico in the 1980s and 1990s finds that across countries and across deposit insurance schemes, market discipline exists even among small insured depositors - who punish risky banks by withdrawing their deposits. Bank fundamentals are at least as important as other factors affecting deposit behavior. Peria and Schmukler examine the banking industries of Argentina, Chile, and Mexico to see if market discipline existed there in the 1980s and 1990s. Using a set of bank panel data, they test for the presence of market discipline by studying whether depositors punish risky banks by withdrawing their deposits. They find that across countries and across deposit insurance schemes, market discipline exists even among small insured depositors-who punish risky banks by withdrawing their deposits. Standardized coefficients and variance decomposition of deposits indicate that bank fundamentals are at least as important as other factors affecting deposits. GMM estimates confirm that the results are robust to the potential endo-geneity of bank fundamentals. This paper - a joint product of Finance, Development Research Group and the Office of the Chief Economist, Latin America and Carribean Region - is part of a larger effort in the Bank to study banking issues affecting developing countries. The study was funded by the LAC Regional Studies Program and by the Bank's Research Support Budget under research project Deposit Insurance Design and Use (RPO 682-90). The authors may be contacted at mmartinezperia@worldbank.org or sschmukler@worldbank.org.