Market Discipline and Deposit Guarantee: Evidence from Australian Banks

Abstract:     
This study examines market discipline in Australian banks and the impact of the 2008 Australian deposit guarantee scheme. Two forms of depositor market discipline were investigated – a quantity impact whereby an increase in bank risk leads to lower deposit volumes, and a price impact whereby an increase in bank risk leads to higher deposit interest rates. Using a random effects (RE) model with an unique unbalanced sample of 25 Australian banks over the period March 2002 to September 2010, market discipline was found at work in the Australian banking sector overall. Testing to see if there are differences between subcategories of banks: Major banks were found to be subject to a quantity impact but a price impact was not found, so there was only limited support for a “too big to fail” effect. We also examined whether the same level of market discipline applies to foreign and domestic banks, deposit quantity in foreign banks is more sensitive to capital risk than in domestic banks, foreign banks on average pay lower interest rates but their rates are less responsive to risk compared to domestic banks. Lastly, we investigated the effect of the introduction of a deposit guarantee in Australia, as expected, it has reduced depositor market discipline. These results are generally robust to various risk proxies and the system GMM estimator.

Number of Pages in PDF File: 46

Keywords: Banks, Market discipline, Deposit quantity, Interest rate, Deposit guarantee

JEL Classification: G21, G28

working papers series