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

29 Pages Posted: 20 Apr 2016

See all articles by Deniz Anginer

Deniz Anginer

World Bank Research

Asli Demirgüç-Kunt

World Bank - Development Research Group; World Bank

Min Zhu

City University of Hong Kong (CityUHK); 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: December 1, 2012

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 leads to excessive risk-taking. This paper examines the relation between deposit insurance and bank risk and systemic fragility in the years leading to and during the recent financial crisis. It finds 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. The 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. Nevertheless, the overall effect of deposit insurance over the full sample remains negative since the destabilizing effect during normal times is greater in magnitude compared with the stabilizing effect during global turbulence. In addition, the analysis finds 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: Banks & Banking Reform, Debt Markets, Deposit Insurance, Emerging Markets, Bankruptcy and Resolution of Financial Distress

Suggested Citation

Anginer, Deniz and Demirgüç-Kunt, Asli and Zhu, Min, How Does Deposit Insurance Affect Bank Risk? Evidence from the Recent Crisis (December 1, 2012). World Bank Policy Research Working Paper No. 6289. Available at SSRN: https://ssrn.com/abstract=2188802

Deniz Anginer (Contact Author)

World Bank Research ( email )

1818 H Street, NW
Washington, DC 20433
United States

Asli Demirgüç-Kunt

World Bank - Development Research Group ( email )

United States
202-473-7479 (Phone)
202-522-1155 (Fax)

HOME PAGE: http://econ.worldbank.org/staff/ademirguckunt/

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

Min Zhu

City University of Hong Kong (CityUHK)

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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