How Does Deposit Insurance Affect Bank Risk? Evidence from the Recent Crisis

Abstract

Deposit insurance is widely offered in a number of countries as part of a financial system safety net to promote stability. An unintended consequence of deposit insurance is the reduction in the incentive of depositors to monitor banks which lead to excessive risk-taking. We examine the relation between deposit insurance and bank risk and systemic fragility in the years leading up to and during the recent financial crisis. We find that generous financial safety nets increase bank risk and systemic fragility in the years leading up to the global financial crisis. However, during the crisis, bank risk is lower and systemic stability is greater in countries with deposit insurance coverage. Our findings suggest that the "moral hazard effect" of deposit insurance dominates in good times while the "stabilization effect" of deposit insurance dominates in turbulent times. The overall effect of deposit insurance over the full sample we study remains negative since the destabilizing effect during normal times is greater in magnitude compared to the stabilizing effect during global turbulence. In addition, we find that good bank supervision can alleviate the unintended consequences of deposit insurance on bank systemic risk during good times, suggesting that fostering the appropriate incentive framework is very important for ensuring systemic stability.

Re-exploring the nexus between monetary policy and banks' risk-taking

“…• using actual car and estimating the mean and standard deviation of roa over a rolling window of 4 or 5 periods (Yeyati and Micco, 2007;Anginer et al, 2014).…”

Bank levy and bank risk‐taking

“…However, the disciplining effects may weaken or even disappear if debt holders are secured by either a deposit insurance or government guarantees (Acharya, Anginer, & Warburton, 2016; Anginera, Demirguc‐Kunt, & Zhu, 2014; Berger & Turk‐Ariss, 2015; Nier & Baumann, 2006; Sironi, 2003). This may be a key concern of policymakers when implementing and labelling new regulatory instruments as they may make explicit that a guarantee provided by the government or a central bank exists what currently is at most implicit.…”

Bank Diversification and Overall Financial Strength: International Evidence

“…Using a sample of manufacturing firms operating in six Asian countries, they conclude that diversification improves performance only in the least developed environments. 14 The use of 2007 as a cut-off point is consistent with Hasan et al (2013) and Anginer et al (2014), among several others. 0.009 ** 0.010 ** 0.010 ** 0.009 * 0.009 ** 0.009 * (0.005) (0.005) (0.005) (0.005) (0.005) (0.005) CREDIT −0.005 *** −0.005 *** −0.005 *** −0.005 *** −0.005 *** −0.005 *** (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) CONC −0.006 *** −0.006 *** −0.005 *** −0.004 *** −0.005 *** −0.006 *** (0.002) (0.002) (0.002) (0.002) (0.002) (0.002) TBANKZ 0.014 *** 0.014 *** 0.013 *** 0.012 *** 0.014 *** 0.014 *** (0.002) (0.002) (0.002) (0.002) (0.002) (0.002) CRISIS −0.140 *** −0.231 *** −0.124 *** −0.613 *** −0.138 *** −0.134 *** (0 Notes: *** Statistically significant at the 1% level, ** Statistically significant at the 5% level, * Statistically significant at the 10% level, Robust standard errors in parenthesis; Estimations obtained from a fixed effects model with robust standard errors clustered at the bank level; Variables are defined in Appendix II.…”