Explicit Deposit Insurance Research Articles

Bank Credit in Uncertain Times: Islamic vs. Conventional Banks

This paper explores whether the impact of economic uncertainty on credit growth differs for Islamic vs. conventional banks. Using a sample of 416 banks (58 Islamic and 358 conventional) in 12 countries, the findings indicate that an increase in economic uncertainty significantly decreases the credit growth of conventional banks but does not have any significant impact on Islamic banks’ credit growth. Our results are robust to alternative specifications and addressing endogeneity concerns using GMM estimators. We further observe that our findings are stronger for the following countries: (1) countries with explicit deposit insurance protection system for Islamic banks, (2) lower foreign dominance, and (3) countries with a higher share of deposits and assets in Islamic banks.

Moral hazard, external governance and risk-taking: Evidence from commercial banks in China

Using a sample of Chinese commercial banks from 2004 to 2017, this paper investigates whether and how external governance mitigates the moral hazard problem in these banks. China launched its first explicit deposit insurance program in 2015. Taking this program as an example, our empirical results show that the implementation of such a program indeed increases risk-taking of these commercial banks and provide evidence of the presence of moral hazard. We further document that improved external governance via a marketization process plays a role in reducing excessive risk-taking and mitigating the moral hazard problem in the Chinese banking sector.

THE TRAVELS OF A BANK DEPOSIT IN TURBULENT TIMES: THE IMPORTANCE OF DEPOSIT INSURANCE DESIGN FOR CROSS‐BORDER DEPOSITS

We examine the impact of the existence on an explicit deposit insurance (DI) scheme and its design features on bilateral cross‐border deposits (CBD) in a gravity model setting. We find that both the absolute quality of a country's DI and its relative quality vis‐à‐vis other countries' DI generally affect depositor behavior. However, during systemic banking crises, cross‐border depositors primarily seek countries with the best DI schemes. Similarly, during the 2008–2009 great financial crisis, the emergency actions taken by the governments, which supply and maintain these safe havens, have led to substantial relocations of CBD. (JEL F34, G18)

An Empirical Investigation into the Effect of Explicit Deposit Insurance and Design on the Liability Structure of Banks

Abstract This paper provides an insight into the behaviour of the liability side of bank balance sheet in response to explicit deposit insurance. It is an empirical investigation into the choice of a rational bank maximizing its bank value in terms of deposit and non-deposit liabilities after the implementation of explicit deposit insurance. The paper tests how banks' liabilities are affected because of the safety net and its design. Banks lower their leverage ratio as a response to the explicit deposit insurance. The paper finds evidence of depositor shifting funds between the types of deposits in the bank as a result of the explicit deposit insurance. It provides evidence of the importance of setting the right coverage in order to prevent the adverse effects that deposit insurance induces. It studies how the safety net design features affect the bank liability structure. The study finds that besides the explicit deposit insurance, the bank liability structure is affected by factors like tax expense, bank size, overheads, and dividend payout.

The Impact of Explicit Deposit Insurance on Market Discipline

This paper studies the impact of explicit deposit insurance on market discipline in a framework that resembles a natural experiment. We improve upon previous studies by exploiting a unique combination of country-specific circumstances, design features, and data availability that allows us to distinguish between demand and supply effects. We show that deposit insurance causes a significant reduction in market discipline. We also show that the effect of deposit insurance depends on the coverage rate. When the coverage rate is more than 60 percent, market discipline is significantly reduced and it is completely eliminated when the coverage rate reaches 100 percent. Our results also suggest that most market discipline comes from large depositors and that the introduction of deposit insurance affected mainly those who were already active in imposing discipline. Our findings emphasize the need for binding coverage limits per depositor, high degrees of co- insurance, and tailor made deposit insurance systems that preserve the incentives of a critical mass of depositors that are willing and able to perform this function.

How do regulatory ability and bank competition affect the adoption of explicit deposit insurance scheme and banks’ risk-taking behavior?

In this study, we investigates how regulatory ability and bank competition affect the adoption of explicit deposit insurance scheme (eDIS) and banks' risk taking behavior under the scheme. We build a regulator-bank dynamic game model to explain why the implicit deposit insurance scheme is not the optimal choice when the regulator's regulatory ability is high. We also find that excessive competition makes banks take extreme risk and in such case eDIS is ineffective in preventing the occurrence of banking crises. Otherwise, eDIS can prevent the occurrence of banking crises effectively although banks take excessive risk under the scheme. Our model identifies that the effects of bank competition and regulatory ability on the banks' risk incentives created by eDIS are interdependent. Empirical analysis on 190 countries worldwide confirms that: (1) higher regulatory ability increases the probability of eDIS adoption. (2) Under the eDIS, less bank competition and higher regulatory ability could reduce the risk of banking during normal times. In addition, increased regulatory ability significantly weakens the positive effect of banking competition on banking risk. (3) Under the eDIS, more bank competition increases the probability of banking crisis occurrence.

The impact of bank competition and concentration on bank risk-taking behavior and stability: Evidence from GCC countries

This paper presents a comprehensive assessment of the impact of competition on bank fragility pre and post financial crisis period in the GCC banking market as measured by bank risk-taking behavior and bank stability during the period 1998–2016. Our results indicate that a higher level of bank competition and the greater degree of concentration adds to financial fragility. The findings further shows that during the 2008 crisis, lower bank competition maintain the stability of GCC banks. We also find that lower level of competition and lower concentration in the banking market increases the risk-taking behavior of the low capitalized, low liquid and small banks which add to fragility in the banking system. Our findings suggest that countries with greater capital stringency, greater supervisory power, greater market discipline, and private monitoring, with explicit deposit insurance schemes, higher shareholder protection, and higher legal efficiency decrease banks’ risk-taking and increase their stability. We also find that greater regulatory restrictions and higher creditor protection decrease banks’ stability and increase risk in concerned countries. We find support for both competition-fragility and competition-stability hypotheses in the GCC banking market. The results also confirm that the use of a single measure of competition is insufficient to assess the role of competition in banking stability.

The Drivers of Institutional Change in a Post-Socialist Economy: the Case of Deposit Insurance Introduction in Russia

The case of deposit insurance introduction in Russia may suggest that institutional change in post-socialist economies was partly driven by subjective factors, and the choice of imported institutions was rather random. The circumstances under which explicit deposit insurance emerged in Russia might explain its subsequent (mal-)functioning and social costs. Material and institutional preconditions were missing at the time the topic of deposit guarantee came up in the parliament. The key actors (large banks controlling most household deposits and their depositors) did not demand hard a formal scheme of deposit protection. The advantage of an explicit protection scheme over the existing implicit one was unclear because of the prevalence of state-owned banks. I suggest that the introduction of deposit insurance was driven by a combination of factors such as: genuine good intentions of its proponents; demonstration effect of western experiences; the desire to disrupt the monopoly of Sberbank and boost the competitiveness of privately-owned commercial banks, probably stemming from ideological bias in favor of private ownership; and, last but not least, search for a new field of activity for deposit insurance initiators themselves. Despite its random selection, the institution of deposit guarantee fit well in the Russian setup because it was consistent with the long tradition of state paternalism.

Determinants of Deposit Insurance Coverage

On a comprehensive duration data set covering 189 countries from 1960 to 2015, we employ a Heckman two-step selection model to investigate determinants of deposit insurance coverage. We find that macroeconomic status, bank structure and regulatory, political institution, legal system and deposit insurance design characteristics have a significant effect on deposit insurance coverage. Moreover, empirical results show that the impact factors are different between developing and developed countries, especially the design characteristics. Specifically, for developing countries, the scheme with the Foreign currency will support a higher coverage. And for developed countries, the Interbank deposits will lead to a lower coverage, but the No coinsurance shows the opposite effect. It is noteworthy that both the Payouts and Backstop from government influence the coverage setting conversely in different samples, which implies that there may be higher banks' risk-taking incentives in developing countries after setting up explicit deposit insurance system.

Effect of explicit deposit insurance premium on the moral hazard of banks’ risk-taking: Around the globe

The adoption of explicit deposit insurance increases the moral hazard of banks’ risk-taking, caused by the decrease in depositors’ discipline. Based on the contract theory, this study probes whether the inception of risk-based deposit insurance premium may limit the moral hazard of banks’ risk-taking triggered by the deposit insurance. This study conducted the analysis on 2,196 banks of 125 countries, covered by the Bankscope database from 2002 to 2014 period. The hierarchical linear models (HLM) were used for empirical estimation of research models. The findings revealed that risk-based deposit insurance premium deteriorated the moral hazard of banks’ risk-taking, incited by the enactment of explicit deposit insurance, while this effect was high for the small banks. Therefore, the small banks were more stable and positively affected by the selection of risk-based deposit insurance premium as compared to the larger counterparts. However, it cannot eliminate this negative effect completely. Hence, the implementation of the premium structure by policymakers on the finding of this study encouraged the depositors and investors’ confidence in the banking system around the globe.

Depositor preference and deposit insurance schemes — challenges for regulatory convergence and regulatory coordination in Asia

This article examines the main challenges for achieving regulatory convergence and coordination for depositor preference rules and explicit deposit insurance schemes at the regional level in Asia. The increasing regionalisation and integration of banking activities in Asia, as reflected in initiatives such as the ASEAN Banking Integration Framework, suggest a need for co-operation in the area of depositor protection in order to maximise the benefits of banking integration and achieve regional financial stability. However, the level of integration and financial stability is likely to be limited by national regulatory sovereignty and control over depositor protection mechanisms and the absence of a political commitment for ex ante cost-sharing and burden-sharing at the regional level.

Subsidized Coordination and Political Bargaining for Bail-Outs

Can banks exploit the political economy to generate revenue? If bank creditors (local depositors) are voters, the bank's capital structure can act as a tool to impact the electorate and thus bail-outs by changing the relative group size of voters who favor as opposed to object bailouts. As the bank relies more on deposit financing, then given a firm failure, the politician grants larger bailouts due to economic voting. Ex ante, this generates a deposit insurance effect that alters the bank's optimal capital structure problem. The creditors' anticipation of high bailouts, allows the bank to reduce funding costs today, thereby increasing revenue. The bank, therefore, faces a trade-off: Classically, more creditors increase the bank's likelihood of failure but given failure, bailouts are larger due to economic voting. Bank funding costs become non-monotone in debt. Depending on the lenience ('influencing') with which non-creditor voters punish the politician when granting bailouts, funding costs can monotonically decline in deposit financing, allowing the bank to set maximally high debt ratio while maintaining voluntary participation of her depositors in a setting where no explicit deposit insurance exists.

Deposit Insurance and the 2008-2009 Global Financial Crisis

Our paper revisits benefits and costs of explicit deposit insurance and examines the role of deposit insurance during the 2008-2009 financial crisis period. The crisis provides an ideal setting to test whether DI achieved its intended purpose. We investigate whether DI influences banks’ ability to retain deposits, interbank market liquidity, loans granted to the industrial sectors, and fund flows across countries, in addition to the risk taking behavior, the usual focus of most studies in the literature. We find supportive evidence that deposit insurance help banks retain deposits and alleviate declines in the amount of corporate loans. It also has positive externalities in the sense that corporate loan spreads have a smaller increase when the country has explicit deposit insurance. Finally, deposit insurance mitigates the global bank’s ‘flight-to-home’ effect. The paper goes beyond examining the mere presence of a deposit insurance and investigates the role of specific deposit insurance designs, including whether DI has risk-based insurance premium, coinsurance, full coverage, ‘risk-minimizing’ arrangements, dual funding sources, and was established by government or not. Indeed, the effects are more pronounced for certain design features.

Political institutions and bank risk-taking behavior

This paper examines the impact of political institutions on bank risk-taking behavior. Using an international sample of banks from 98 countries over the period 1998–2007, I document that sound political institutions stimulate higher bank risk-taking. This is consistent with the hypotheses that better political institutions increase banks’ risk by boosting the credit market competition from alternative sources of finance and generating the moral hazard problems due to the expectation of government bailouts in worst economic conditions. While it is contrary to the hypotheses that better political institutions decrease banks’ risk by lowering the government expropriation risk and the information asymmetries between banks and borrowers. The results are robust to a number of sensitivity tests, including alternative proxies of bank risk-taking and political institutions, cross-sectional bank- and country-level regressions, endogeneity concerns of political institutions, country income levels, explicit deposit insurance schemes and sample extension from 1998 to 2014. I also examine the interdependence between political and legal institutions and find that political and legal institutions complement each other to influence bank risk-taking behavior.

Effects of Deposit Insurance on Self-Discipline of Bank Franchise Value

Foreign research has shown that the bank franchise value is the important mechanism of the bank’s risk self-discipline. However, the relationship between the franchise value and the risk behavior of our bank must be based on our special financial background. Before the implementation of explicit deposit insurance system in China, there has been an implicit deposit insurance system guaranteed by the government. The traditional literature suggests that the implicit deposit insurance system provides a strong guarantee for commercial banks, which may weaken the risk discipline effect of the bank’s franchise value, and the reasonable explicit deposit insurance system is superior to the implicit deposit insurance system. In the financial context of the explicit deposit insurance system, the self-discipline effect of the franchise value will be repaired. Based on the reality of establishing an explicit deposit insurance system in China, this paper uses the Tobin Q value to measure the franchise value of 16 listed banks in China. The relationship between the franchise value and risk of bank before and after the introduction of explicit deposit insurance is studied by using panel data model. The results show that before the implementation of the explicit deposit insurance system, the self-discipline effect of the franchise value is completely ineffective in the context of the government-guaranteed implicit deposit insurance system. The cross-item coefficient of the explicit deposit insurance system and the franchise value is significantly negative. It shows that the implementation of the explicit deposit insurance system has played a role in restoring the self-discipline effect of the bank’s franchise value.

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

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.

Deposit Insurance and Bank Liquidity: Does Ownership Structure Matter?

We examine how the level deposit insurance coverage affects bank liquidity. We also test the role of ownership in the relationship between deposit insurance coverage and bank liquidity. This study uses quarterly data of Indonesian banks from Q1:2002 - Q2:2008. We argue that the presence of explicit deposit insurance changes a bank‘s behavior in liquidity management in the form of decreasing asset liquidity. We find some evidence on the negative impact of deposit insurance coverage on bank liquidity. However, little is found on the role of ownership structure. The credibility of deposit insurance system and implicit guarantee are the main policy implications.

Bank credit default swaps and deposit insurance around the world

We investigate the impact of deposit insurance schemes on banks' credit risk – a predictor of failure and a key element in the current financial crisis. Unlike most studies, which use balance sheet measurements of risk, we adopt a forward-looking and market-based measure of bank credit risk: the credit default swap (CDS) spread. We find that banks in countries with explicit deposit insurance systems have higher CDS spreads, supporting the “moral hazard” view. The results suggest that deposit insurance design features that lessen the adverse impact are risk-adjusted premium, coinsurance systems, government-established systems, “risk-minimizing” systems, and systems with dual-funding sources. Full coverage appears to stabilize bank risk only during the financial crisis period. More stringent bank regulation, such as capital adequacy regulation and independent supervision, could reduce the undesirable impact of deposit insurance. Deposit insurance seems to help stabilize volatile markets, as evidenced during the financial crisis and in countries with greater market volatility. In addition, we find that the adverse impact of deposit insurance on bank credit risk is more pronounced for banks with low asset quality and low liquidity.

Industry Environment, Bank Risk-Taking and Deposit Insurance

Classic theories always ignore the influence of the banking industry environment on deposit insurance’s regulation mechanism. With information transparency and competition degree dimensions, we build a banking risk-taking model and find that the optimal regulation mechanism does not depend on the advantage of the scheme oneself, but it is a trade-off of bank’s risk incentive which involves the banking industry environment. Under the suitable competition degree, fair-priced explicit deposit insurance is optimal when the information transparency is high. Otherwise implicit deposit insurance is optimal; moreover if the competition is fierce, then deposit insurance’s regulation fails. We find that in the regulation feasible region, the improvement of industry environment will correct moral hazard; however in the regulation failure region, we perfect the exit mechanism of the bank which is in trouble by giving the disposal cost pricing strategy. And the most important is that this regulation mechanism demonstrates the endogenous cause of the exist of China’s implicit guarantee system featured by strict administrative control. Based on our research we think that if we do well with the delegating power and strengthening regulation, improve the industry environment, and the collaboration with different policies then we will reform the regulation system successfully and improve the society’s economic efficiency.

The impact of deposit insurance on depositor behavior during a crisis: A conjoint analysis approach

Abstract We investigate the effectiveness of initiating deposit insurance at the outset of a banking crisis. Using a conjoint analysis approach that allows us to consider the simultaneous impact of multiple deposit insurance attributes and various counterfactuals, we ask a multinational sample of respondents how they would view hypothetical account profiles following the failure of a large competing bank. Previous experience matters: respondents from countries without explicit deposit insurance exhibit greater withdrawal risk, suggesting that the introduction of deposit insurance during a crisis may be only partially successful in preventing bank runs. They also impose a higher deposit interest rate premium. Having a long-term bank relationship reduces withdrawal risk, as does the absence of co-insurance.