Does Deposit Insurance Promote Financial Depth? Evidence from the Postal Savings System During the 1920s

Abstract

This paper tests whether deposit insurance promotes financial depth by influencing depositor behavior. To do so, we rely on two schemes operating in the U.S. during the 1920s: the Postal Savings System and the deposit insurance schemes that some states had adopted. We exploit the discontinuity in deposit insurance across state borders and compute changes in postal savings deposits in cities located along the borders of states that did and did not have deposit insurance. We examine the relative growth of postal savings deposits in pairs of border cities when bank suspensions occurred within a short radius (10, 20, and 30 miles). Our results indicate that, following a bank suspension within a 10-mile radius, deposits in postal savings offices located in the non-deposit insurance state increased by 16 percent more than deposits in the neighboring postal savings office located in the deposit insurance state. The magnitude of the effect declines with bank suspension distance. It disappears when deposit insurance is not in effect. Using county-level data, we find that deposit insurance is associated with a 56 percent increase in local banking capacity.