Making Depositors Greedy and Careless: Government Safety Nets and the Degradation of Depositor Discipline

Abstract

In emerging countries, deposits play an important role in banks’ total funding; hence depositor discipline may impact significantly banking performance and the financial system’s stability. My paper investigates the reaction of bank depositors to interest rates as well as signs of banks’ risk, before and after the recent banking crisis in Vietnam. I demonstrate that before the crisis, the level of deposit financing in banks depended on the interest rates offered, but also on measures of the banks' risk-taking. After the crisis, the second relationship wanes: Bank customers still react actively to interest rates but not to risk, presumably because they have learned that their deposits are safe, whatever risk the bank is taking.