Risk-Shifting Behavior at Commercial Banks Under Different Deposit Insurance Systems: Further Evidence from U.S. Markets

Abstract:     
This paper provides further evidence regarding the effect of deposit insurance on the risk-shifting behavior at commercial banks in the United States. In particular, we compare the risk-shifting behavior of commercial banks before and after adopting the risk-based capital requirements in the U.S. market. To test the risk-shifting behaviors, we propose a new pricing model for the valuation of deposit insurance premium using a barrier option framework. We also estimate the unknown parameters using a maximum likelihood estimation method rather than Ronn and Verma’s (1986) two-equation approach. We find that the risk-shifting behaviors at commercial banks have reduced significantly but have not disappeared after the adoption of a risk-based deposit insurance system. The risk-shifting behavior at commercial banks still exists, especially for those banks with high risks or high financial distress probabilities. We find that the deposit insurance reform prevents large banks from shifting their risk to the deposit insurers as well.

Number of Pages in PDF File: 40

Keywords: Deposit insurance, Risk-shifting behavior, Risk-based premium system, Barrier option approach, Maximum likelihood estimation

JEL Classification: G21, G28

working papers series