Deposit Insurance Scheme Research Articles

Moral Hazard and the deposit insurance cap: a case study of Northern Rock and Silicon Valley Bank

ABSTRACT The main contention of this article is that government insurance for bank deposits should be unlimited. In spite of claims made in the literature concerning the moral hazard dangers of deposit insurance schemes, I argue that these claims are unconvincing; indeed, the empirical record - discussed here in relation to Northern Rock and SVB - demonstrates that uninsured depositors exhibit similar behaviour to their insured counterparts, undermining the claim that limiting insurance induces risk-monitoring. In contrast, there is strong evidence that in developed jurisdictions with established, mature regulatory institutions, deposit insurance does not result in excessive risk-taking on the part of banks. The significant financial stability benefits accruing to insuring bank deposits include the elimination of depositor runs, a reduction in the incentives for unregulated bank-like financial intermediation (shadow banking), and heightened competition. Activity restrictions and other measures can reduce any heightened risk-taking which emerges as a result of wider insurance coverage.

PUBLIC AWARENESS OF DEPOSIT INSURANCE AND INVESTOR COMPENSATION SCHEMES IN BULGARIA

The purpose of deposit insurance and investor compensation schemes is to protect the clients of banks and investment intermediaries by providing compensation in the case of unavailability of clients’ deposits or assets. Generally, knowledge about the activities of both schemes is rather limited by the public. This is observed not only in developing countries, but also in the developed ones. This problem is called public awareness. The paper investigates the public awareness of the main components of the financial safety net in Bulgaria – the deposit insurance scheme and investor compensation scheme - based on a random distribution of a questionnaire among 232 people. The investigation is not considered as being representative but it indicates tendencies in the public awareness of both schemes in Bulgaria. The analysis in the paper is focused on the questions regarding the main activities of the deposit insurance and investor compensation schemes as well as the amount of guarantee, scope of both schemes, compensations payments events, the behavior of depositors and investors in cases of trouble events, etc. The survey shows that in terms of the deposit insurance the awareness of participants is above average, while regarding investor compensation, the results are well below average, one could even say that such awareness is lacking at all. The results of the survey provide information that the efforts of the regulators and financial safety net schemes should be directed to increasing the awareness of depositors and investors in Bulgaria about the benefits and limitations of both schemes.

How do depositors respond to banks' discretionary behaviors? Evidence from market discipline, deposit insurance, and scale effects

We investigate how depositors respond to the U.S. bank's discretionary behaviors. We document higher deposit rates for banks that engage more in earnings management, suggesting evidence of market discipline. The quantile regressions, which dissect bank behavior at the right tail of deposit costs distribution, point out that the leveraged effect of earnings management is more significant in low- and high-deposit costs banks. Additionally, we note that depositors monitor banks' discretionary behavior to a greater extent before and during the crisis; however, they become less severe after the crisis. Interestingly, there is strong evidence of depositors monitoring large banks before, during, and after the crisis, suggesting the “too-big-to-fail” perception does not hold for our sample. The study also documents evidence of monitoring by insured and uninsured depositors over the sample period. After the crisis, we find a “wake-up call” for uninsured depositors, and more importantly, insured depositors remain sensitive to banks' reporting quality despite a weakening of incentives due to the increase of deposit insurance limit. The evidence is crucial when confirming that a deposit insurance scheme does not completely remove the deposit discipline. Our findings are useful for regulators and policymakers concerned about strengthening the market discipline.

The mediating role of capital on deposit insurance and financial stability: evidence from Islamic and conventional banks

PurposeThis study aims to evaluate the interaction between bank capital and explicit deposit insurance scheme (DIS) on the financial stability of Islamic and conventional banks.Design/methodology/approachThe author's sample covers 52 Islamic and 108 conventional banks operating in 12 countries over the period 2000–2021 using the random-effects generalized least squares (RE-GLS) regression technique.FindingsThe author's results reveal that bank capital negatively mediates the relationship between explicit DIS and the financial stability of both Islamic and conventional banks. Additionally, explicit DIS has a positive impact on the financial stability of conventional banks. However, the results are mixed for Islamic banks, as the effect of explicit DIS is positive for the Middle East and North Africa (MENA) region but negative for the South and Southeast Asia (SSA) region. Finally, the interaction between explicit DIS and the COVID-19 pandemic has a negative effect on conventional banks operating in the MENA region, while it has a positive effect on Islamic banks operating in the SSA region.Research limitations/implicationsThe findings of this paper have important implications for regulators in evaluating DIS policies and in anticipating any potential adverse consequences that might arise for both Islamic and conventional banks in normal and crisis times. Policymakers should strive to preserve the benefits of DIS while mitigating the destabilizing effects of its interaction with capital ratios.Originality/valueThis study introduces a novel aspect by examining the mediating role of capital in the relationship between explicit DIS and the financial stability of Islamic and conventional banks.

COVID-19 pandemic and explicit deposit insurance scheme: an analytical study

COVID-19 pandemic and explicit deposit insurance scheme: an analytical study

A Component Expected Shortfall Approach to Systemic Risk: An Application in the South African Financial Industry

The accelerated growth and interconnectedness of financial institutions and movement towards products and activities outside the regulatory purview have been met with huge concerns. South Africa is one of the emerging economies that this conundrum has beset. Any potential instability in the financial sector likely poses insurmountable consequences and unprecedented government intervention, especially given that the country currently has no deposit insurance scheme. Although it is easy to justify the channels through which banks contribute to destabilising financial markets, it remains a controversial issue for insurers and other non-banking institutions. This study aims to empirically quantify the contribution of banks and insurers to aggregate the systemic risk of their respective industries by employing the component expected shortfall (CES). The CES is a robust quantitative systemic risk measure that allows for a comprehensive assessment of systemic risk by considering the contributions of individual financial components. Our findings demonstrate that the rankings from the CES framework are closely aligned with the regulatory D-SIB surcharges of the banking entities included in the study. The close alignment of both approaches is primarily due to the consideration of the size of an institution, amongst other factors.

Determinants of Liquidity Risk in the Countries of the European Economic Area

The paper documents cross-country variation in the relationship between the deposit insurance scheme and liquidity risk in banks and explores the banking sector specific and macroeconomic determinants that can explain the variation. There is a lack of articles exploring the phenomenon in Europe, authors studying the issue focus on the United States and other parts of the world, so it is difficult to apply their results to Europe. The results of their research are also ambiguous. Using data from 28 countries of the European Economic Area by means of panel regression calculated with the use of GLS estimator with random effects, I established that an increase in deposit insurance coverage reduces the risk of liquidity. The study provides new information to help evaluate deposit insurance schemes across EEA countries.

How Should Crypto Lending Be Regulated Under EU Law?

The collapse of Genesis is the latest in a cascade of failures of crypto lenders. The last year has seen numerous major crypto lenders, such as Celsius, Voyager and BlockFi, going out of business in domino-like fashion. The failures have revealed the vulnerabilities of crypto-market lenders’ business model, most notably the liquidity and maturity mismatches in their loan portfolios, and their markedly weak corporate governance. The present article explores avenues to regulate crypto lending within the framework of EU financial services regulation. It argues that crypto lenders should be taken as falling within the definition of credit institutions under EU law, and thus, as a result, should be subject to the stringent licensing and prudential requirements introduced by the Capital Requirements Directive and Regulation. Prudential regulation is one of the ways that have been suggested for the regulation of crypto-market operators, alongside the investor protection framework. Taking into account that crypto lenders easily operate on a cross-border basis and that prudential regulation is fully harmonized in the EU, we take an EU-wide perspective and focus our analysis on EU law, rather than member state laws. In addition, prudential regulation can deal with any systemic risk issues with which investor protection regulation cannot deal. However, in order to avoid moral hazard and not give investors the false impression that crypto lenders are safe too-big-to fail institutions, we suggest that crypto lenders should not enjoy the full protection of prudential regulations. In particular, they should not be offered lender of last resort support and they should not be allowed to subscribe into a deposit insurance scheme. Even though it is often said that crypto markets pose no risk to the regulated sector due to limited interconnectedness, it should be noted that due to the high leverage of crypto investors, the real risk to the regulated sector comes from the possibility of crypto investors massively liquidating their positions in other asset markets.

The importance of deposit insurance credibility

Sovereigns usually back up their deposit insurance arrangements to lend them credibility. When the sovereign is in distress, the credibility of deposit insurance might be threatened, with detrimental effects to financial stability. We investigate the behavior of depositors during the euro area sovereign debt crisis to understand the importance of deposit insurance credibility. We find that depositors responded to foreign banks’ decision to convert their subsidiaries into branches. By relocating their deposits into these newly formed branches during a period of sovereign distress, depositors became insured by a deposit insurance scheme with a stronger fiscal backstop. These results document a novel channel through which sovereign-bank links can be reinforced during a crisis: the credibility of deposit insurance.

Leading Operational Risk Events For South African Banks: A Reputational Risk Perspective

Banks have been exposed to operational risk for decades. Therefore, there is a strong reason to believe that the exposure to operational risk will only increase in future due to improved transparency as required by regulators as well as the increased reliance on improved technological automation within banks in the digital area. The aim of this article was to identify the leading operational risk events that will most likely lead to reputational risk for South African banks. Primary data were collected from 417 depositors in Gauteng, South Africa, using a self-structured questionnaire where hypothetical operational risk events were employed. External fraud had the highest reputational risk rating, followed by execution and delivery. Six out of the eight events, therefore, were considered severe in terms of the likelihood that depositors will withdraw. Seven out of the eight events, therefore, were considered severe in terms of the percentage of funds that depositors will withdraw. Also, seven out of the eight events were considered severe in terms of the likelihood of creating a negative perception in the minds of depositors. The majority of research in this area has stemmed from developed countries. The significant difference between previous research in the developed regions and South Africa lies in the absence of a deposit insurance scheme in the South African banking sector. Operational risk events that might be severe in developed countries might even be more severe in the South African context without proper banking insurance protecting depositors. Therefore, the novelty of this article lies in the contribution towards empirical evidence from one of the most sophisticated and promising emerging markets by identifying the most severe operational events on the reputational risk for banks.

Deposit insurance and market discipline

Limited coverage is a standard feature in deposit insurance schemes. It is used to limit moral hazard, and achieves this objective by reinforcing market discipline: depositors have more incentives to monitor banks’ risk-taking if they have skin in the game. In this paper, I study market discipline and coverage levels by analyzing the relationship of funding costs and deposit growth with banks’ risk. I use a database of Colombian banks’ balance sheets and take advantage of a sudden, significant, and exogenous increase in the coverage level that occurred in April 2017. I find evidence of market discipline throughout the period of analysis and most results are consistent with it not being reduced by the change in the coverage level. The results are nuanced, however. Two variables are impacted: one in the quantity and the other in the price dimension. Furthermore, results also vary when I look at specific groups of banks separately. Market discipline is not present in big banks. Too big-to-fail perceptions seem to limit it. This is also the case for banks concentrated in fully insured deposits, where limited coverage has a less prevalent role.

Deposit insurance for New Zealand: New scheme for the banking industry

Using recent data from the New Zealand banking industry, this paper examines the most important factors that determine bank risk. We use a sample of 24 banks in New Zealand from the period from 2012 to 2021, using quarterly data. The risk-based deposit premium is preferable to be implemented in New Zealand as it calculates the risk attached to each bank as the flat rate is simpler yet imposes moral hazard. Thus, we use a weighting method based on statistical learning models using gradient boosted model to predict the most important variable that explains bank risk. The result shows that capital equity is the most important variable that can predict bank risk that weighs more than 40%. This research indicated that a risk-based premium is preferable and fairer than a flat-rate premium to reduce moral hazard (Bloecher et al., 2003). This study supports the deposit insurance schemes in New Zealand as a part of the system to maintain banking stability (Cerrone, 2018)

Covid-19 Pandemic and Explicit Deposit Insurance Scheme: Analytical Study

Covid-19 Pandemic and Explicit Deposit Insurance Scheme: Analytical Study

Liquidity And Deposit Insurance: The Case Of Deposit-Taking Microfinance Institutions In Low-Income Sub-Saharan Africa

The objective of this study was to examine the relationship between liquidity and deposit insurance of Deposit-taking Microfinance Institutions (DTMFIs) in Low-Income Sub-Saharan Africa (LISSA). Several DTMFIs in the region defaulted in meeting withdrawals on deposits and collapsed with depositors’ funds. The failure of DTMFIs to be liquid has dire consequences such as contagion risk due to the sudden and unexpected deposit runs and oblivion of depositors’ funds, which further condemn the small savers into extreme poverty levels. Panel data from the Microfinance Information Exchange for the years 2006 to 2017 of 64 DTMFIs sampled across 18 LISSA countries was utilised. The estimated random effects results showed that explicit deposit insurance is positive and significantly related to liquidity. Additionally, the capital adequacy ratio and the Basel implementation dummy are positive and significant determinants of liquidity. The study concluded that designing and implementing explicit deposit insurance schemes mitigates liquidity risk in depository microfinance and maintaining adequate capital adequacy levels and implementation of Basel recommendations improves the liquidity positions of the LISSA DTMFIs. The study recommended formulation of deposit insurance policies that embrace microfinance deposits of all types and adherence to the Basel capital adequacy standards complements deposit protection in hedging liquidity risk.

How Do Depositors Respond to Bank Dividend Policy? Evidence from Market Discipline, Global Financial Crisis and COVID-19 Pandemic

Our study investigates how depositors respond to the bank dividend policy via the interest rate channel. The results suggests that by paying dividend, banks mitigate the information asymmetry between insiders and outsiders, then enjoying a lower deposit cost than banks that do not pay dividend. Dividend-paying banks that are subject to higher funding costs may enjoy a greater decrease of funding costs than non-payers. Banks that are under greater pressure from regulators, but encounter losses have to pay higher deposit costs when deciding to pay dividend. The study emphasizes the downside of deposit insurance scheme when documenting the indifference of insured but uninsured depositors during the global financial crisis, but the COVID-19 crisis, suggesting the wake-up calls for depositors.

An Uncommon Commons: Government’s Role in Constituting an Unusual Credit Union Deposit Insurance Scheme

While Ostrom-inspired research has proven an important corrective to the simplistic “markets or government” dichotomy that continues to shape social and administrative sciences, this paper uses a case study to suggest that in some circumstances, our understanding of the commons could be enriched by giving more weight to the role governments can play in helping to constitute a human-made commons. In particular, this paper examines the case of a little-known deposit insurance scheme run by credit unions in the Canadian province of Saskatchewan that has operated without once incurring a deficit for 70 years despite offering the kind of unlimited deposit insurance frowned upon by policymakers. We find that the provincial government played an important role in constituting the scheme and helping it operate, effectively, as a polycentric commons that until recently, satisfied all the design principles that tend to characterize successful collective management. The resulting argument is simple: it would be difficult to understand the stability of Saskatchewan’s credit union deposit insurance scheme without also understanding how government supported its operation as a commons.

A Regulatory Perspective on the Actual Challenges for the European Deposit Insurance Scheme

The European financial regulation is evolving with new and specific forms of cooperation for the member states, enhancing concepts and innovative rule of law, particularly featuring the actual level of harmonization. This paper investigates the European deposit insurance scheme, in the context of the European law development, in reply to the current economic and social challenges and in accordance with the principles of the free market. The methods of research include a theoretical investigation of the relevant literature, a comparison of the proposed regulation and regulation in force, synthesis, and deduction. The research results are based on the assessment of the progress of negotiation in building efficient mechanisms to stimulate money saving conduct for individuals and legal persons, globally and within the European Union. Acknowledging the status of the three pillars of the European banking union legislative package, the member states have unanimously agreed that the framework established by the Directive from 2014 needed a bracing approach, to ensure more protection and to support enhanced financial integration. The analysis carried out showed the importance of the European deposit insurance scheme in the context of the present global challenges. The money saving conduct was strongly influenced by the regulation for the deposit guarantee mechanism, while the tight estimated agenda for the final regulatory proposal asks for ingenious cooperation to reach a consensus within members states. The research showed the imperative to build common legislation for the member states and a future direction of investigation to evaluate the effects of the gap between the domestic regulation and milestone generated by the European directives in each state legal framework.

Blessing or curse? Government funding of deposit insurance and corporate lending

A key policy to limit the possibility of bank runs is an explicit deposit insurance scheme, which can be either privately or government funded. Using syndicated loans from 63 countries during the period 1985–2016, we study the effect of government involvement in deposit insurance funding on price and non-price characteristics of loans. We show that changes from purely private-funded to either government-funded or jointly funded deposit insurance increase all-in-spread-drawn by approximately 4.6 %, further increase loan fees, decrease loan maturity, and increase the use of performance pricing provisions. Our findings are consistent with the moral hazard problem behind government-funded deposit insurance schemes.

The reform of deposit insurance in China: how China evolves from implicit deposit insurance to explicit deposit insurance

ABSTRACT Since the global financial crisis (GFC), deposit insurance, as an essential part of the financial safety net, has been significantly developed to be an effective mechanism to contain bank runs and market fears. Unlike many advanced markets having deposit insurance for years, China has just launched its first explicit deposit insurance scheme, effective from 1st May 2015, remarking that the Chinese financial safety net has been primarily completed. This article not only provides a retrospective analysis of the development of deposit insurance in China, but also comprehensively examines the features of the first Chinese deposit insurance scheme with reference to international principles and standards. Through the analysis, this research tries to explore the features of the first Chinese deposit insurance scheme and argues that the Chinese deposit insurance scheme has to be well designed in consideration of the country specifics.

Private deposit insurance, deposit flows, bank lending, and moral hazard

We examine the role of private unlimited deposit insurance as a complement to federal deposit insurance for deposit flows, bank lending, and moral hazard during a crisis. We find that banks whose deposits are federally and privately fully insured obtain more deposits and expand lending, in contrast to banks whose deposits are only federally insured. We also document that privately insured banks remain prudent in the loan origination process during the subprime crisis. Our results offer novel insights into depositor and bank behavior in the presence of multiple deposit insurance schemes with differential design features. They also illustrate how private sector solutions incentivize prudent bank behavior to strengthen the financial safety net.