How Does Deposit Insurance Affect Bank Risk? Evidence from the Recent Crisis

25 Pages Posted: 30 Oct 2012 Last revised: 8 Dec 2013

See all articles by Deniz Anginer

Deniz Anginer

Simon Fraser University (SFU)

Asli Demirgüç-Kunt

World Bank

Min Zhu

City University of Hong Kong (CityU); World Bank - Development Research Group; University of Michigan, Stephen M. Ross School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: August 2013

Abstract

Deposit insurance is widely offered in a number of countries as part of a financial system safety net to promote stability. An unintended consequence of deposit insurance is the reduction in the incentive of depositors to monitor banks which lead to excessive risk-taking. We examine the relation between deposit insurance and bank risk and systemic fragility in the years leading up to and during the recent financial crisis. We find that generous financial safety nets increase bank risk and systemic fragility in the years leading up to the global financial crisis. However, during the crisis, bank risk is lower and systemic stability is greater in countries with deposit insurance coverage. Our findings suggest that the “moral hazard effect” of deposit insurance dominates in good times while the “stabilization effect” of deposit insurance dominates in turbulent times. The overall effect of deposit insurance over the full sample we study remains negative since the destabilizing effect during normal times is greater in magnitude compared to the stabilizing effect during global turbulence. In addition, we find that good bank supervision can alleviate the unintended consequences of deposit insurance on bank systemic risk during good times, suggesting that fostering the appropriate incentive framework is very important for ensuring systemic stability.

Keywords: bank risk, systemic risk, deposit insurance

JEL Classification: G21, G28

Suggested Citation

Anginer, Deniz and Demirgüç-Kunt, Asli and Zhu, Min, How Does Deposit Insurance Affect Bank Risk? Evidence from the Recent Crisis (August 2013). Journal of Banking and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2168168 or http://dx.doi.org/10.2139/ssrn.2168168

Deniz Anginer

Simon Fraser University (SFU) ( email )

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

Asli Demirgüç-Kunt (Contact Author)

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

Min Zhu

City University of Hong Kong (CityU)

83 Tat Chee Avenue
Kowloon
Hong Kong
China

World Bank - Development Research Group

1818 H Street NW
Washington, DC DC 20433
United States

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI 48109
United States

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