The effect of raising deposit insurance coverage in times of financial crisis – Evidence from Croatian microdata

Abstract

Typically, depositors in transition countries react very sensitively to the safety of deposits. Faced with rising deposit outflows in October 2008, many transition countries were forced to extend the limits of deposit insurance coverage. Has this calmed private agents? Or has it caused more uncertainty? We analyze these questions by employing household survey data for Croatia from exactly the time deposit insurance was extended. First, we provide evidence how the financial crisis has affected trust in banks and trust in the local currency. Then, we show that the increase in deposit insurance coverage had an immediate and positive impact on how people perceived the safety of deposits and the credibility of the local currency. Therefore, our results suggest that this policy measure helped to prevent a more serious and dangerous meltdown of deposits and a further shift towards foreign currency denominated assets. However, despite this effect the perceived safety of deposits remained lower than it was before the financial crisis. We also consider this finding to be of relevance for other countries of Central, Eastern and Southeastern Europe.