Could Good Intentions Backfire? An Empirical Analysis of the Bank Deposit Insurance

Bao, W., J. Ni, "Could Good Intention backfire? An Empirical Analysis of Bank Deposit Insurance," Marketing Science, Forthcoming

55 Pages Posted: 11 Apr 2016 Last revised: 24 Oct 2016

See all articles by Weining Bao

Weining Bao

University of Connecticut

Jian Ni

Virginia Tech - Pamplin College of Business

Date Written: May 2016

Abstract

The recent financial crisis led to the expansion of deposit-insurance coverage in many countries. We develop a structural model of the banking market, in which banks act as financial intermediaries between consumers who have funds and businesses that seek loans, and explore the implications of such policies for banks and depositors. Our results indicate the policy could erode market discipline and increase banks’ moral hazard. As a result, banks extend their lending to riskier loans than they would have in the absence of the policy. We find this policy may even harm consumers. Moreover, market competition magnifies the lack of market discipline and induces additional moral hazard for excessive risk taking. Counterfactuals indicate banks reduce their deposit interest rates by at least 0.07% in a duopoly market (0.34% in an oligopoly market) and almost triple their risk caps under the new policy. The estimated losses of depositors’ welfare are equivalent to at least a 0.28% drop in deposit interest rates.

Keywords: Deposit insurance, market discipline, moral hazard, consumer welfare, structural model, indirect inference

JEL Classification: G21, G28, G33, L11, L13

Suggested Citation

Bao, Weining and Ni, Jian, Could Good Intentions Backfire? An Empirical Analysis of the Bank Deposit Insurance (May 2016). Bao, W., J. Ni, "Could Good Intention backfire? An Empirical Analysis of Bank Deposit Insurance," Marketing Science, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2761957

Weining Bao

University of Connecticut ( email )

Storrs, CT 06269-1063
United States

Jian Ni (Contact Author)

Virginia Tech - Pamplin College of Business ( email )

1016 Pamplin Hall
Blacksburg, VA 24061
United States

HOME PAGE: http://https://sites.google.com/site/jiannicmu/

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