Deposit Insurance and Market Discipline
36 Pages Posted: 25 Oct 2019
Date Written: September 30, 2019
A standard feature in deposit insurance schemes that counterbalances moral hazard is limited
coverage. It achieves this by reinforcing market discipline: depositors have greater incentives to
monitor banks’ risk-taking. 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 no indication of it diminishing
when coverage levels changed. Furthermore, funding costs appear to be impacted by size-related
variables and there is no evidence of market discipline when analyzing only big banks.
Too-big-to-fail perceptions seem to impact market discipline.
Keywords: Deposit Insurance, Market Discipline, Deposit Insurance Coverage
JEL Classification: E65, G21, G28
Suggested Citation: Suggested Citation