Liquidity Risk of Banks, Deposit Diversification and Insurance During Financial Crises: Evidence from G8 and BRICS Countries

Abstract

This paper studies the relationship between liquidity demand risk, deposit diversification and insurance in 12 countries during the period 2005-2014. We capture liquidity risk by focusing on the unfunded loan commitments. We find that higher diversification in the deposit base can reduce the impact of liquidity demand risk during the crisis by decreasing the cost of funding, increasing the funding inflow, maintaining the total amount of loan lending and enhancing the liquid ratio. However, it is interesting that higher concentrations in the deposit base may reduce the cost of funding increase the deposit inflow and liquid ratio in normal times. Finally, we find that although deposit insurance has a positive impact during the crisis, its effect cannot mitigate the liquidity demand risk. The “moral hazard effect” of deposit insurance is greater than the “stabilization effect” on liquidity demand risk. Banks in a country with deposit insurance may be more likely to suffer liquidity demand risk than banks in a country without this safety net.

Keywords: liquidity risk, deposit diversification, insurance, banks

JEL Classification: G01, G21