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
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: Suggested Citation