How Do Insured Deposits Affect Bank Risk? Evidence from the 2008 Emergency Economic Stabilization Act

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in Non-Technical SummaryIn the course of the recent financial crisis and the ongoing sovereign debt crisis, understanding the design and consequences of deposit insurance schemes has anew become an important policy issue. Deposit insurance is a corner stone of many banking systems worldwide because it helps protect small savers and prevent bank runs. However, it also gives banks incentives for excessive risk-taking because, first, it weakens the market discipline carried out by creditors, and second, mispricings of the deposit insurance premium, which come from the regulators' limited ability to assess risks and to charge risk-adjusted premiums, make higher risk-taking attractive for shareholders. Whether deposit insurance impacted banks' risk-taking in the U.S. during the recent financial crisis is not yet explored. The effect of deposit insurance may be complementary to other important aspects of the financial crisis, such as the effect of bank CEO incentives, bank equity, and government bailout policies on banks' risk-taking.This paper explores how a bank's amount of insured deposits affects its stability and lending decisions during the recent financial crisis. We use variation introduced by the U.S. Emergency Economic Stabilization Act in October 2008, which increased the deposit insurance coverage from $100,000 to $250,000 per depositor and bank. This change increased the total sum of insured deposits in the U.S. from roughly $4,800 billion to roughly $5,300 billion. Importantly for our analysis, banks were affected differently. For some banks, this event significantly increased the amount of insured deposits (``affected banks''). For other banks, it only had a minor effect (``unaffected banks'').Our empirical analysis shows that an increase in the amount of insured deposits causes the affected banks to become more risky relative to the unaffected banks. This is reflected in estimations for two alternative risk measures: banks' predicted probabilities of default and banks' z-scores (a measure for a bank's ability to absorb losses by its bank capital). Further, our analysis shows that affected banks increase their investments in commercial real estate loans, which is considered a particularly risky loan category, relative to unaffected banks after the regulatory change. This presumably contributes to a relatively lower asset quality of affected banks following the increase of insured deposits, as reflected in a significantly ...

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“…The rightmost column presents the normalized differences (Imbens and Wooldridge, 2009;Lambert et al, 2017). A normalized difference larger than 0.25 indicates that the differences in the trends between both groups of banks are significant.…”

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“…Public deposit insurance creates moral hazard for banks which can thus finance risky assets, using insured deposits, poorly monitored by depositors. As a result, the banking system may be more vulnerable to crises of insolvency (empirically this thesis is confirmed by such scholars as: Anginer, Demirgüc-Kunt, Zhu, 2013;Lambert, Noth, Schuwer, 2013;Lé, 2013).…”

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“…Column 1 reports estimates obtained over the entire sample using Deposit insurance reform. Column 2 interacts Affected (EESA) with Post (EESA) focusing on US banks from Lambert et al (2017), where Post (EESA) is an indicator equal to one for the period 2009-2012. Column 3 considers a time window of two years around EESA, where the pre-and post-period are defined as 2007-2008 and 2009-2010, respectively.…”

“…In line with Lambert, Noth, and Schüwer (2017), we obtain information on the bank-level change in insured deposits (scaled by total assets) around the EESA. Because our sample of US banks is considerably smaller than that of Lambert et al (2017), we rely on a different definition of treatment and control group. We assign a bank to the treatment group if its change in insured deposits is above the 75th percentile, and to the the control group otherwise.…”