Deposit Insurance and Market Discipline

36 Pages Posted: 25 Oct 2019 Last revised: 23 Dec 2020

See all articles by Juan Carlos Quintero-V

Juan Carlos Quintero-V

EDHEC Business School (EDHEC); World Bank

Date Written: December 30, 2019

Abstract

Limited coverage is a standard feature in deposit insurance schemes. It is used to limit moral
hazard, and achieves this objective by reinforcing market discipline: depositors have more incentives to monitor banks’ risk-taking if they have skin in the game. In this paper, I study market discipline and coverage levels by analyzing the relationship of funding costs and deposit growth with banks’ leverage, non-performing loans and profitability. I use a database of Colombian banks’ balance sheets and take advantage of a sudden, significant, and exogenous increase in the coverage level that occurred in 2017. I find evidence of market discipline throughout the period of analysis, and there is no indication that it was reduced by the change in the coverage level. The results vary, however, when I look at specific groups of banks separately. Market discipline is no longer present when analyzing only big banks. Too-big-to-fail perceptions seem to limit it. This is also the case for banks concentrated in insured deposits, where limited coverage has a less prevalent role. Finally, in banks that rely more heavily on uninsured deposits, there is evidence of market discipline, and the data show that it was reduced when coverage increased.

Keywords: deposit insurance, market discipline, deposit insurance coverage level

JEL Classification: G01, G21, G28

Suggested Citation

Quintero-V, Juan Carlos, Deposit Insurance and Market Discipline (December 30, 2019). Available at SSRN: https://ssrn.com/abstract=3470428 or http://dx.doi.org/10.2139/ssrn.3470428

Juan Carlos Quintero-V (Contact Author)

EDHEC Business School (EDHEC) ( email )

France

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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