Deposit Insurance and Depositor Monitoring: Quasi-Experimental Evidence from the Creation of the Federal Deposit Insurance Corporation

Abstract

In the Banking Acts of 1933 and 1935, the United States created the Federal Deposit Insurance Corporation, which ensured deposits in commercial banks up to $5,000. Congress capped the size of insured deposits so that small depositors would not run on banks, but large and informed depositors-such as firms and investors-would continue to monitor banks' behavior. This essay asks how that insurance scheme influenced depositors' reactions to news about the health of the economy and information on bank's balance sheets. An answer arises from our treatment-andcontrol estimation strategy. When deposit insurance was created, banks with New York state charters accepted regular and preferred deposits. Preferred depositors received low, fixed interest rates, but when banks failed, received priority in repayment. Deposit-insurance legislation diminished differences between preferred and regular deposits by capping interest rates and protecting regular depositors from losses. We find that before deposit insurance, regular depositors reacted more to news about banks' balance sheets and economic aggregates; while preferred depositors reacted less. After deposit insurance, this difference diminished, but did not disappear. The change in the behavior of one group relative to the other indicates that deposit insurance reduced depositor monitoring, although the continued reaction of depositors to some information suggests that, as intended, the legislation did not entirely eliminate depositor monitoring.

Deposit Insurance and Depositor Monitoring: Quasi‐Experimental Evidence from the Creation of the Federal Deposit Insurance Corporation

“…5. In a companion paper (Anderson, Richardson, and Yang 2017), we describe depositors' choice in greater detail. Depositors chose between safer, lower return preferred accounts and slightly riskier, slightly higher return regular accounts.…”

“…7. To save space, we report additional specifications, which serve as robustness checks, in an online extended version of this essay (Anderson, Richardson, and Yang 2017). To control for factors that shifted households' and firms' supply of deposits, we have rerun all the regressions from equation (1) with the related specification:( 2)…”

“…We overcome this challenge by computing consistent categories across all years at the finest possible categorization. Details of this process can be found in our working paper on the website of the National Bureau of Economic Research (Anderson, Richardson, and Yang 2017).…”

Reducing Moral Hazard at the Expense of Market Discipline: The Effectiveness of Double Liability Before and During the Great Depression

“… See Demirgüç-Kunt and Detragiache (2002),Demirgüç-Kunt and Huizinga (2004),Iyer and Puri (2012) ,Karas, Pyle, and Schoors (2013), Iyer, Puri, and Ryan (2016), Iyer, Jensen, Johannesen, and Sheridan (2016 12Wheelock (1992),Alston, Grove, and Wheelock (1994),Wheelock and Wilson (1995), and Calomiris and Jaremski (2016) examine how the adoption of state deposit insurance affects depositor monitoring. In contrast,Anderson, Richardson, and Yang (2017) study the effect of federal deposit insurance on market discipline.…”

Reducing Moral Hazard at the Expense of Market Discipline: The Effectiveness of Double Liability before and during the Great Depression

“…See Demirgüç-Kunt and Detragiache (2002),Demirgüç-Kunt and Huizinga (2004),Iyer and Puri (2012) ,Karas, Pyle, and Schoors (2013), Iyer, Puri, and Ryan (2016), Iyer, Jensen, Johannesen, and Sheridan(2016)12Wheelock (1992),Alston, Grove, and Wheelock (1994),Wheelock and Wilson (1995), and Calomiris and Jaremski (2016) examine how the adoption of state deposit insurance affects depositor monitoring. In contrast,Anderson, Richardson, and Yang (2017) study the effect of federal deposit insurance on market discipline.…”