How Do Regulatory Ability and Banking Market Structure Affect Explicit Deposit Insurance Scheme Adoption and Bankss Risk Taking?

Abstract

This study investigates how regulatory ability and banking market structure affect explicit deposit insurance scheme (eDIS) adoption and banks’ risk taking under eDIS. We find that: (i) The regulatory ability exists a threshold if the government regulator’s regulatory ability above the threshold, the implicit deposit insurance scheme (iDIS) is not the optimal choice. (ii) Excessive competitive banking market structure leads to the existence of an invalid region of both eDIS and iDIS, in which the bank takes extreme risk. (iii) In the valid region of eDIS, the bank takes excessive risk and the effects of banking market structure and regulatory ability on the bank’s risk are interdependent. Empirical analysis on 190 countries worldwide 1996-2011 confirms that regulatory ability is the determinant of eDIS adoption, whereas the more competitive banking market structures are more prone to experience a banking crisis. The results also indicate a negative effect of regulatory ability on banking risk, and the effect of market structure on banking risk is negative either, as predicted. Moreover, the results support the prediction that the increase of regulatory ability weakens the negative effect of banking market structure on banking risk.