Does Deposit Insurance Improve Financial Intermediation? Evidence from the Russian Experiment

Abstract

This study examines how the introduction of deposit insurance affects depositors and banks, using the deposit-insurance scheme introduced into the Russian banking system as a natural experiment. The fundamental research question is whether the introduction of deposit insurance leads to a more effective banking system as evidenced by increased deposit-taking and decreased reliance upon State-owned banks as custodians of retail deposits. We find that banks entering the new deposit-insurance system increased both their level of retail deposits and their ratios of retail deposits to total assets relative to banks that did not enter the new deposit insurance system. These results hold up in a multivariate panel-data analysis that controls for bank- and time-random effects. The longer a bank had been entered into the deposit insurance system, the greater was its level of deposits and its ratio of deposits to assets. Moreover, this effect was stronger for regional banks and for smaller banks. We also find that implementation of the new deposit-insurance system had the effect of “leveling the playing field” between State-owned banks and privately owned banks. Finally, we find strong evidence of moral hazard following implementation of deposit insurance in the form of increased bank risk-taking. Financial risk and, to a lesser degree, operating risk increased following implementation.

Keywords: Bank, Deposit Insurance, Financial Intermediation, Moral Hazard, Russia, State-Owned Bank

JEL Classification: E53, G21, G28