Switching Costs, Deposit Insurance and Deposit Withdrawals from Distressed Banks

Abstract

We study retail deposit withdrawals from large European commercial banks which incurred substantial investment losses in the wake of the U.S. subprime crisis. We first show that the propensity of households to withdraw deposits increases with the magnitude of bank distress. This withdrawal risk is, however, substantially mitigated by client-level switching costs that arise from tight client relationship with a distressed bank or limited access to branches of non-distressed banks. Our findings provide empirical support to the Basel III liquidity regulations which emphasize the role of well-established client relationships for the stability of bank funding.