Do Depositors Discipline Banks and Did Government Actions During the Recent Crisis Reduce this Discipline? An International Perspective

Abstract:     
The recent financial crisis highlights the importance of both regulatory and market discipline. ‎Government reactions to the crisis included expanding deposit insurance coverage and rescuing ‎troubled institutions, including some institutions that might not otherwise be considered too ‎important to fail. These actions may have the unintended consequence of a reduction in market ‎discipline that might otherwise penalize banks for risk-taking behavior. To address this issue, we ‎first test for the presence of depositor discipline effects in the period leading up to the financial ‎crisis in both the US and the EU. Second, we test whether depositor discipline declined during ‎and after the crisis. We find significant depositor discipline prior to the crisis in both the US and ‎EU, but this varies between the US and the EU as well as with banking organization size and ‎with listed versus unlisted status. We also find that the data are consistent with the hypothesis ‎that depositor discipline declined during and after the crisis as a result of the government actions.‎

Number of Pages in PDF File: 45

Keywords: Market Discipline, Depositor Discipline, Banks

JEL Classification: G21, G28

working papers series