Uninsured Deposits Research Articles

Shadow Banking and Financial Stability under Limited Deposit Insurance

I study the relation between shadow banking and financial stability in an economy in which banks are susceptible to self-fulfilling runs and in which government-backed deposit insurance is limited. Shadow banks issue only uninsured deposits while commercial banks issue both insured and uninsured deposits. The effect of shadow banking on financial stability is ambiguous and depends on the (exogenous) upper limit on insured deposits. If the upper limit on insured deposits is high, then the presence of a shadow banking sector is detrimental to financial stability; shadow banking creates systemic instability that would not be present if all deposits were held in the commercial banking sector. In contrast, if the upper limit on insured deposits is low, then the presence of a shadow banking sector is beneficial from a financial stability perspective; shadow banks absorb uninsured (and uninsurable) deposits from the commercial banking sector, thereby shielding commercial banks from runs. While runs may occur in the shadow banking sector, the situation without shadow banks and a larger amount of uninsured deposits held at commercial banks is worse. JEL Classification: E44, G21, G28

Supervisory Enforcement Actions and Depositorss Reaction: Monitoring, Running, or Living a Quiet Life?

Public announcement of formal enforcement actions against banks for safety and soundness reasons may enhance effective depositor monitoring or cause depositors to overreact, leading to disruptive runs. We test these competing hypotheses, using hand-collected data on enforcement actions and bank-quarter or branch-year data on deposits and other bank characteristics from 2000 through 2014. Our baseline results show that total deposits at punished banks decrease by 9.5% in the post-enforcement year, with uninsured deposits declining by 20% and insured deposits falling by 7.9%. These findings survive in a large battery of robustness tests and highlight that enforcement actions enhance rational depositor monitoring over and above punished banks’ financial condition.

A Tale of Two Runs: Depositor Responses to Bank Solvency Risk

ABSTRACTWe examine heterogeneity in depositor responses to solvency risk using depositor‐level data for a bank that faced two different runs. We find that depositors with loans and bank staff are less likely to run than others during a low‐solvency‐risk shock, but are more likely to run during a high‐solvency‐risk shock. Uninsured depositors are also sensitive to bank solvency. In contrast, depositors with older accounts run less, and those with frequent past transactions run more, irrespective of the underlying risk. Our results show that the fragility of a bank depends on the composition of its deposit base.

Uninsured deposits and excess share insurance at US credit unions: the impact on risk and returns to members

Using NCUA credit union call report data, I find that uninsured depositors and excess share insurers provide valuable monitoring benefits for credit unions for the years following the 2008 financial crisis. I find that the capital ratio, liquidity ratio, and delinquencies-to-total loans and leases decrease with an increase in the percentage of deposits that exceed the $250,000 per depositor regulatory threshold of standard deposit insurance. The influence of uninsured depositors is generally more significant for small credit unions than large credit unions. The results for the precrisis period are not consistent with those of the postcrisis period. However, the results are consistent across the six-year period following the financial crisis. Overall, the results are consistent with the hypothesis that uninsured depositors are value-maximizing stakeholders who exercise control over the firm.

Deposit Rate Advantages at the Largest Banks

We estimate differences in funding costs between the largest banks and the rest of the industry. Using deposit rates offered at the branch level, we eliminate many non-risk-related differences between banks. We document significant and persistent pricing advantages at the largest banks for comparable deposit products and deposit risk premiums. Between 2007 and 2008, the risk premium paid by the largest banks was 39 bps lower than the risk premium at other banks under the baseline estimate after controlling for common risk variables. These findings are consistent with an economically significant too-big-to-fail subsidy paid to the largest banks through lower risk premiums on uninsured deposits.

The Run for Safety: Financial Fragility and Deposit Insurance

We study a run on uninsured deposits in Danish banks triggered by a reform that limited deposit insurance coverage. Using a unique dataset with information about all individual accounts in Danish banks, we show that the reform caused a 50% decrease in deposits above the insurance limit in non-systemic banks, but a much smaller decrease in systemic banks which experienced less withdrawals from uninsured accounts, but also more openings of new uninsured accounts. Our results highlight the significant risks from a differential reallocation of uninsured deposits across banks and, in turn, the need for high insurance limits during a crisis.

Public lending to private hedge funds is inefficient, unstable, unconstitutional and unanimously disagreeable

Public funds include federally insured deposits held under the custody of private banks, central bank loans and taxpayer funds. The principal finding of this paper is that lending such public funds through a private banking system to private hedge funds allied with the banks is inefficient, unstable, fundamentally unfair (unconstitutional) and unanimously disagreeable. This finding is akin to the unanimously agreeable safe central banking policy (Acharya, 1991-2016) which, in dynamic general equilibrium, (a) eliminates federal guarantee of bank deposits, (b) offers every business enterprise and household an option to keep in the central bank any part of its deposits it wants to be held absolutely safely, (c) completely deregulates all private banks without any privilege to rob public or private wealth like too-big-to-fail or too-big-to-be-jailed status or the power of market making and clearing. Safe central banking is the only way to make private banks responsible to hold sufficient capital to attract uninsured private deposits like the trading houses currently do. The private banks will then have complete freedom to lend their uninsured deposits to private hedge funds. The Volker Rule (NYT, January 30, 2010), incorporated in the Dodd-Frank Act of 2010, is an infeasible and unworkable band-aid for the moral-hazard driven systemic robbery of wealth creators wrought by the government-ordained private banking custody of public funds. The established systemic moral-hazard problem can be efficiently and constitutionally resolved only through unanimously agreeable safe central banking. Current proposals on overhauling of Fannie and Freddie made by various pundits of systemic robbery amount to a gargantuan amount of public lending to private hedge funds and, hence, inefficient, unstable, unconstitutional and unanimously disagreeable.

Exposure to interbank market and risk-taking by Mexican banks

Banks can avoid bank runs and panic using the interbank market as a type of coinsurance. Moreover, because of the possibility of losing financial assets, they theoretically have incentives to monitor their peers, borrowing in this market. This paper examines whether bank risks are explained by their exposure to the interbank market. The market discipline hypothesis suggests that bankers are well equipped to monitor their peers, and the interbank borrowing is par excellence an uninsured deposit. Consequently, banks with a larger exposure to the interbank market should present strong bank fundamentals. Using a sample of 37 Mexican banks, from December 2008 to September 2012, and dynamic panel models based on the SYS GMM estimator, I did not find evidence in favor of the market discipline hypothesis. These results are robust to different indicators of bank risk and exposure to interbank markets. This is a wake-up call for policymakers, who should restore market discipline in interbank operations, following the disclosure policy in Basel III.

The Financial Industry's Plan for Resolving Failed Megabanks Will Ensure Future Bailouts for Wall Street

The Financial Industry's Plan for Resolving Failed Megabanks Will Ensure Future Bailouts for Wall Street

Deposit Competition and Financial Fragility: Evidence from the US Banking Sector

We develop a structural empirical model of the US banking sector. Insured depositors and run-prone uninsured depositors choose between differentiated banks. Banks compete for deposits and endogenously default. The estimated demand for uninsured deposits declines with banks' financial distress, which is not the case for insured deposits. We calibrate the supply side of the model. The calibrated model possesses multiple equilibria with bank-run features, suggesting that banks can be very fragile. We use our model to analyze proposed bank regulations. For example, our results suggest that a capital requirement below 18 percent can lead to significant instability in the banking system. (JEL E44, G01, G21, G28, G32)

Market discipline by bank creditors during the 2008–2010 crisis

We investigate whether uninsured depositors, insured depositors, and general creditors exhibit evidence of quantity market discipline during the recent financial crisis. To establish which types of creditors expect to incur loss, we evaluate the FDIC's expectations about losses to creditors at banks that failed between 2008 and 2010. Our results show that quantity market discipline tends to begin far enough in advance to signal to both banks and supervisors that corrective actions can and should be taken. Furthermore, creditors are able to distinguish between banks of different risk levels. Our findings support several policy implications for encouraging market discipline.

Understanding Bank Liquidity Risk Using Realized Gains and Losses on Available-for-Sale Securities

I show that realized gains and losses (RGL) from the sale of available-for-sale (AFS) securities, a historical cost accounting variable, has forward looking information about bank's liquidity risk. Intuitively, the bank's decision to sell a security is based on private information about its own risk, and RGL reveals that information. Specifically, I demonstrate that the absolute magnitude of RGL on AFS securities in the period immediately prior to the failure of Lehman Brothers negatively predicts the change in uninsured deposits in the post-Lehman crisis period, and is most economically significant for the banks with lowest Tier 1 capital and return on assets. In contrast, fair value changes of AFS securities do not have predictive power.

Uninsured deposits as a monitoring device: Their impact on bond yields of banks

We empirically analyze the impact of uninsured deposits on a bank’s cost of public debt. Uninsured depositors can exert market discipline over a bank and potentially reduce its agency cost of debt through informed monitoring. We use a sample of public bond issues by U.S. bank holding companies from 1994 to 2013 and find statistically strong evidence that banks with more uninsured deposits relative to their assets issue bonds with a lower interest rate. Findings suggest a one standard deviation increase in uninsured deposits is associated with a 46–64 basis point decrease in bond yield. In addition, we find that bonds issued by banks with higher default risk or lower reputation benefit more from uninsured savers. Our paper contributes to the literature that explores market discipline and provides evidence that banks can benefit from it through a lower borrowing cost.

A Tale of Two Runs: Depositor Responses to Bank Solvency Risk

Using depositor-level data, we examine whether depositor actions reflect solvency risk for a bank that faced runs. We find that depositors with loans and bank staff are less likely than others to run in a low solvency-risk shock, but relatively more likely to in a high solvency-risk shock. Uninsured depositors always run more and this difference grows markedly in a high solvency-risk shock. In contrast, depositors with older accounts run less, and those with more frequent past transactions run more, irrespective of the underlying solvency risk. Our results show how depositor composition affects bank fragility and help characterize stable deposits.

Depositor discipline and the bank ' s incentive to monitor

Purpose – The aim of this paper is to examine the question of the specialness of banks by addressing concerns raised in the recent studies and deriving policy implications for the future of banking. The specialness of banks has been well documented in the finance literature. More recent research, however, calls into question the special nature of banks. Design/methodology/approach – We use event study methodology to study 423 bank loan announcements from 1988 to 1996 and examine the returns relative to proxies for the bank ' s monitoring incentives and skill using ordinary least squares (OLS) regressions. Findings – Our results indicate borrower abnormal announcement returns are positively related to proxies for the bank ' s monitoring incentives and skill as measured by: the ratio of uninsured deposits to total loans; a risk-adjusted measure of recovered charge-offs; and the relative bank-to-borrower capital ratio. Research limitations/implications – The results reveal how the fragile nature of the bank ' s structure improves the bank ' s incentives to monitor borrowers. Practical implications – Our results can inform the current debates in the Fed and in Congress surrounding reapplying the Glass-Steagall Act and limiting the size of banks. We show that banks were special before the Gramm-Leach-Bliley Act and when fewer banks belonged to the too-big-to-fail category. This suggests that reregulating banks to re-establish their fragile nature will re-establish them as information-generating intermediaries instead of just transactional institutions. Originality/value – Our findings have not previously been documented but are broadly consistent with models developed by Calomiris and Kahn (1991) and especially Diamond and Rajan (2001).

Pomoc ohroženým bankám - teorie, realita a měnové dopady

The recent financial crisis has significantly modified the approach to helping troubled banks. The traditional role of the central bank has shifted toward non-credit forms of assistance, provided mainly by the state, and even toward assisting insolvent banks. State assistance - directly or through specialized institutions - mainly concerned banks too big to fail, i.e. systemically important banks. State aid should be forthcoming only once funds available from shareholders, owners of subordinated debt and uninsured depositors have been exhausted. Credit by a central bank should be granted only to temporarily illiquid banks. Primarily as this credit assistance can have significant monetary implications, in as much as it leads to the growth of reserves in the banking system. The impact on the economy then depends primarily on the credit activity of commercial banks. The author compares theory against practice and, using the U.S. and the EMU as an example, analyses the monetary impact using the development of money multipliers.

EVALUATING THEORIES OF BANK RUNS WITH HETEROGENEITY RESTRICTIONS

This paper empirically tests theories of bank runs. We use a structural panel VAR to extract runs from deposit market data. Identification exploits cross-sectional heterogeneity in deposit insurance: we identify bank runs as adverse deposit market supply shocks hitting uninsured banks harder compared to insured. Conditional on a run, we study the behavior of uninsured banks with bad and good fundamentals. We find that both experience runs, but deposit outflows at the former are more severe. Panic effects, which affect all uninsured deposits alike, irrespective of fundamentals, dominate in the aggregate. Insured banks partially absorb the outflow of uninsured deposits.

Bank asset allocation: the effectiveness of market monitoring

Purpose – The purpose of this paper is to study the effectiveness of market discipline on banks’ risk-taking behavior based on how swiftly banks respond to market information. Design/methodology/approach – A simplified incentive model provides the necessary justification for two types of market disciplines: first, monitoring by uninsured market participants, and second, risk premium in terms of interest spread required by risk-averse depositors. Panel data regression is carried out for both surviving and failed US banks for the period 1999:Q4-2007:Q3 to examine the role of market discipline, bank capital, and macroeconomic shocks. Findings – The paper finds that banks which failed during 2007:Q4-2010:Q4 suffered from fundamental weaknesses in their asset quality relative to the surviving banks prior to the crisis. Originality/value – The paper focusses on two questions: In what circumstance does market monitoring exist? And how can market incentives affect banking firms’ actions? The first question is studied in a simplified incentive model that provides justification for two types of market discipline. Given that, the effectiveness of market discipline is empirically tested, using the US banking data in the period leading up to a surge in the number of bank failures in 2007-2010. The paper's results show that failed institutions with large size were relatively less responsive to early warning signals of declining uninsured deposits and rising deposit spread.

Cyclical adjustment of capital requirements: A simple framework

We present a model of an economy with heterogeneous banks that may be funded with uninsured deposits and equity capital. Capital serves to ameliorate a moral hazard problem in the choice of risk. There is a fixed aggregate supply of bank capital, so the cost of capital is endogenous. A regulator sets risk-sensitive capital requirements in order to maximize a social welfare function that incorporates a social cost of bank failure. We consider the effect of a negative shock to the supply of bank capital and show that optimal capital requirements should be lowered. Failure to do so would keep banks safer but produce a large reduction in aggregate investment. The result provides a rationale for the cyclical adjustment of risk-sensitive capital requirements.

Beware of German Gifts Near Their Elections: How Cyprus Got Here and Why it is Currently More Out than in the Eurozone

Key points:• The situation in Cyprus arose due to banking overreach, insufficient regulation, excessive government deficits, poor debt management and collateral damage from previous Eurogroup bailouts.• The amount needed is small in absolute values, but large relative to the size of the economy. The Troika was unwilling to fund more than 10bn Euros.• Extreme delay from the departing Christofias government and persistence from the Troika led to the bailing-in depositors to cover the gap. An attempt to spread the pain by suggesting a “shares-for-deposits swap” for all Cypriot depositors, (bailing-in even insured depositors) was defeated in the Cypriot parliament.• In subsequent negotiations, insured depositors were unharmed: uninsured depositors in the largest two Systemically Important Financial Institutions, Laiki Bank and Bank of Cyprus were affected.• Local debt default and forced rollover are part of the bailout, but as it currently stands, holders of external debt are to be paid in full. The exception is the Russian Federal Republic: the Troika has demanded that Cyprus negotiate a restructuring of that direct government loan.• As a result of the above actions, Cyprus is left facing an unprecedented economic depression; the link between weak financial institutions and a weak state has not been broken, making a second bailout very likely.• Cyprus has capital controls, deteriorating financial situation and needs to defend itself against local and domestic lawsuits that might overturn decisions. Cyprus is still dangling precariously from the Euro exit cliff.