Market Reaction to Risky Banks: Did Generous Deposit Guarantee Change it?

53 Pages Posted: 26 Feb 2008

See all articles by Zeynep Onder

Zeynep Onder

Bilkent University - Faculty of Business Administration

Suheyla Ozyildirim

Bilkent University - Faculty of Business Administration

Abstract

Turkey experienced a massive banking crisis, which resulted in the loss of more than a thousand managerial jobs and the closure of 21% of all bank branches in the market, in February 2001. In this paper, we study the behavior of the market and the banks in Turkey before the crisis, from 1988 to 2000, which includes the period of full deposit insurance. The empirical results showed that not only depositors but also borrowers reacted negatively to risky banks and punished them even more during the period of generous government guarantee. However, in the same period, banks were found to increase their moral hazard behavior significantly. Although the International Monetary Fund and the World Bank recommend explicit deposit insurance for developing countries, the findings of this paper suggest that deposit insurance may not be an effective policy tool to improve market confidence, and it does not guarantee a stable economic environment even when the market reacts negatively to the moral hazard behavior of banks.

Keywords: Deposit Insurance, Market Discipline, Moral Hazard, Turkey

JEL Classification: G21, G28

Suggested Citation

Onder, Zeynep and Ozyildirim, Suheyla, Market Reaction to Risky Banks: Did Generous Deposit Guarantee Change it?. World Development, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1097495

Zeynep Onder

Bilkent University - Faculty of Business Administration ( email )

06533 Bilkent, Ankara
Turkey
(90)(312) 290 2038 (Phone)
(90)(312) 266 4958 (Fax)

Suheyla Ozyildirim (Contact Author)

Bilkent University - Faculty of Business Administration ( email )

06800 Bilkent, Ankara
Turkey

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