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.market discipline;deposit insurance;deposit insurance coverage

Deposit insurance, moral hazard and market monitoring

The paper analyses the relationship between deposit insurance, debt-holder monitoring, and risk taking. In a stylised banking model we show that deposit insurance may reduce moral hazard, if deposit insurance credibly leaves out non-deposit creditors. Testing the model using EU bank level data yields evidence consistent with the model, suggesting that explicit deposit insurance may serve as a commitment device to limit the safety net and permit monitoring by uninsured subordinated debt holders. We further find that credible limits to the safety net reduce risk taking of smaller banks with low charter values and sizeable subordinated debt shares only. However, we also find that the introduction of explicit deposit insurance tends to increase the share of insured deposits in banks’ liabilities. JEL Classification: G21, G28banking, Deposit Insurance, Market Monitoring, Moral Hazard

Risk-adjusted deposit insurance premiums

Deposit insurance ; Risk ; Bank supervision ; Federal Deposit Insurance Corporation

Reflections on deposit insurance

A crucial public policy issue is the need for reform of the nation’s deposit insurance system. This article discusses the role of deposit insurance and outlines some proposals for reform.Bank deposits ; Deposit insurance

Restoring banking's safety net: deposit insurance's steeper cost

A recession now in its 21st month has presented tremendous challenges to the deposit insurance system. Actual and expected bank failures have left the Deposit Insurance Fund below its mandated level. The Federal Deposit Insurance Corporation has responded by raising the premiums banks pay. Premiums will rise for banks in the Dallas-based Eleventh Federal Reserve District--but not by as much as they will for banks in the rest of the country. This additional cost is an important consideration because every dollar spent on insurance is a dollar that can't be lent or otherwise invested.Deposit insurance ; Federal Deposit Insurance Corporation ; Bank failures

The major supervisory initiatives post-FDICIA: Are they based on the goals of PCA? Should they be?

The prompt corrective action provisions in FDICIA 1991 provide the supervisors with an unambiguous goal: "to resolve the problems of insured depository institutions at the least possible long-term cost to the deposit insurance fund." Yet performance of the regulators in achieving this goal has been lacking in that substantial losses continue to be imposed on the insurance funds when banks fail. Is PCA misguided, or are there incentive defects in the law and how the requirements are being administered? This paper analyzes these issues in the context of recent proposals to reform the deposit insurance system.Federal Deposit Insurance Corporation Improvement Act of 1991 ; Financial institutions ; Deposit insurance ; Bank supervision

Market discipline and financial safety net design

There has been little empirical work on the effectiveness of safety nets designed for banks, for lack of data on safety net design across countries. The authors examine cross-country data on bank-level interest expense and deposit growth for evidence of market discipline in individual countries. In addition, using cross-country information on deposit insurance systems, they investigate the impact of explicit deposit insurance (and its key features) on bank interest rates and market discipline. They find that: 1) Many countries retain some degree of market discipline, regardless of the type of safety net. 2) The existence of explicit deposit insurance lowers banks'interest expenses and makes interest payments less sensitive to bank risk factors, especially bank liquidity. 3) Higher explicit coverage, broader coverage, and the existence of an earmarked insurance fund increase required-deposit rates and reduce market discipline. 4) Private (especially joint) management of insurance schemes lowers deposit rates and improves market discipline.Financial Intermediation,Banks&Banking Reform,Insurance&Risk Mitigation,Payment Systems&Infrastructure,Insurance Law,Banks&Banking Reform,Financial Intermediation,Insurance&Risk Mitigation,Insurance Law,Financial Crisis Management&Restructuring

Design, Structure and Implementation of a Modern Deposit Insurance Scheme

One of the important consequences to be drawn from the course of the financial crisis up to now is the insight that more attention must be paid in the future to the factors of liquidity, liquidity management and liquidity protection. That holds true for the protection of the stability of an individual bank as it does for that of a whole national or even international financial system. The liquidity problems of a bank can certainly have a variety of causes. However, as an examination of the history of bank insolvencies and financial crises shows, an accelerated withdrawal of bank deposits by unsecured customers nearly always leads in the end to the collapse of an institution and, as an ultimate consequence, to a national or even international banking crisis. This insight has also brought the deposit insurance institutions in many countries around the world to the attention of political, regulatory and banking management discussions. The rapid, politically necessary, factually often not well founded, guarantee promises made by many governments have shown those responsible that in Europe the need for a fundamental revision of the present deposit insurance schemes must be urgently addressed. In most industrialized countries of the OECD, as well as in a range of other states, working groups are studying the necessary revisions and adjustments of the relevant institutions to meet the new economic and political conditions. Even if solutions of this sort continue to be arranged differently from one country to another on the basis of differing regulatory, historical and structural circumstances, a consensus is emerging over the important basic questions of deposit insurance system design and architecture. As a result of the worldwide financial crisis most European countries massively increased their coverage limits for their national deposit insurance schemes in the fall of 2008. Where no deposit insurance existed, it was introduced. Existing systems were critically scrutinized. In most countries the maximum insurance coverage was raised and the eligible deposit base was extended. Some individual states have even promised an unlimited deposit protection (in some cases with a time restriction). Under the pressure of an increasing number of bank failures these promises were made without revising the existing deposit insurance schemes themselves. In the course of 2009, both the individual European states and the EU itself then set about scrutinizing their existing protection schemes and mechanisms and revising the existing national deposit insurance schemes. It is accepted throughout the world that well designed deposit insurance is an important element in a national safety net for maintaining and extending the stability of the financial system. The design and structure, but also the implementation, of a deposit insurance scheme (DIS) of this sort throws up numerous institutional, procedural and instrumental questions. Such operative and strategic issues must be answered against the background of the overall national circumstances and in line with the country specific realities of the respective financial intermediate system. However, there is a series of topics that can be assessed and solved independently of such individual circumstances. This is even more the case since the worldwide revision of the deposit insurance schemes offers the opportunity to create the conditions for a future harmonization of national deposit insurance schemes at least within Europe. An assimilation of this sort is, in turn, the basis for future EU-wide or perhaps even European depositor protection, which, like any broadly based guarantee, would certainly be more efficient than a multitude of national solutions. This publication intends to make a contribution to the ongoing discussion of the complex questions connected with the further development of European deposit insurance schemes. Both complementing and extending the broad range of theoretical literature available, it focuses on some key design questions of modern deposit insurance schemes, on the discussion of their basic structural elements and on the appropriate consequences for the stakeholders in deposit insurance. We focus on: - the derivation of the most important requirements of a modern European deposit insurance, and the - discussion of specific organizational aspects and fundamental institutional requirements as well as of solutions for selected system building blocks. The first chapter analyzes the institutional framework of deposit insurance schemes and its various aspects of cost/benefit considerations. The second chapter discusses the fundamentals of modern deposit insurance. The third chapter examines selected strategic and instrumental questions concerning the organization and implementation of deposit insurance schemes. The fourth chapter focuses on some questions related to the international harmonization and coordination of the design of deposit insurance schemes. In all sections we address some lessons learned from the recent financial turmoil. The fifth chapter finally addresses some conclusions and sketches some policy implications for designing and implementing a modern deposit insurance scheme.Deposit insurance, risk-based premium, risk-adjusted pricing, premium calculator, system risk, fund size, funding, guarantee promises, depositor categories, eligible deposits, covered deposits, membership, expected loss, pan-european deposit insurance system, moral hazard, resolution regime, payout

Measuring the Impact of Full Coverage Deposit Insurance Policy in a Probit Model : A Study of the Privately Owned Commercial Banks in Turkey

This study analyzes the impact of full coverage deposit insurance policy as well as bank specific factors and macro economic conditions on bank failure over a sample of 35 privately owned commercial banks in Turkey for the period 1991-1998. The model predicts a high probability of bank failure associated with full coverage deposit insurance policy.Bank failure, Deposit Insurance

Depositinsurance around the globe : where does it work?

Explicit deposit insurance has been spreading rapidly in recent years, even to countries not advanced in financial and institutional development. Economic theory indicates that deposit insurance design features interact--for good or ill--with country-specific elements of the financial and governmental contracting environment. The authors document the extent of cross-country differences in deposit insurance design and review empirical evidence on how design features affect private market discipline, banking stability, financial development, and the effectiveness of crisis resolution. This evidence challenges the wisdom of encouraging countries to adopt explicit deposit insurance without first addresing weaknesses in their informational and supervisory environments.Financial Intermediation,Payment Systems&Infrastructure,Banks&Banking Reform,Financial Crisis Management&Restructuring,Insurance&Risk Mitigation,Banks&Banking Reform,Financial Intermediation,Insurance&Risk Mitigation,Financial Crisis Management&Restructuring,Insurance Law