Full Deposit Insurance and the Moral Hazard Problem: The Case of the Turkish Banking System

Abstract

This paper analyzes the effects of the full deposit insurance system introduced in 1994 on the financial performance of Turkish commercial banks using the experimental design approach. The research findings support the moral hazard hypothesis. The findings indicate that banks subject to moral hazard behavior show significant increases in foreign exchange position risk and deterioration in capital adequacy relative to their benchmark after the introduction of the full deposit insurance system. This excessive risk-taking is related to the moral hazard behavior by commercial banks. The research results indicate that the complete deposit insurance system distorts the incentive structure of commercial banks and thus prevents the proper functioning of the market discipline mechanism and leads to excessive risk-taking.

Keywords: Banking, Deposit Insurance, Moral Hazard

JEL Classification: G21