The Importance of Deposit Insurance Credibility

37 Pages Posted: 28 Sep 2020

See all articles by Diana Bonfim

Diana Bonfim

Banco de Portugal; Catholic University of Portugal (UCP) - Catolica Lisbon School of Business and Economics

João A. C. Santos

Federal Reserve Bank of New York; New University of Lisbon - Nova School of Business and Economics

Date Written: July 7, 2020

Abstract

The success of deposit insurance arrangements at eliminating bank runs is likely closely tied to their credibility. We investigate this hypothesis building on two episodes which tested the insurance protection offered by the Portuguese arrangement in the midst of the country's sovereign debt crisis. Our results show that Portuguese depositors responded to foreign banks' decision to convert their subsidiaries into branches by relocating their deposits into the latter. We find a similar response following the announcement that insured depositors in Cyprus would lose part of their savings. On both instances responses are concentrated on household deposits. Given that foreign banks' branches offer the insurance protection of these banks' home countries, rather than that granted by their host country arrangement, our findings confirm that the credibility of the deposit insurance arrangement is critical for the protection it offers banks against the risk of depositor runs. These results show that sovereign-bank links can be detrimental to financial stability through a novel channel: the credibility of deposit insurance.

Keywords: bank deposits, deposit insurance, bank runs, market discipline

JEL Classification: G01, G21, G28

Suggested Citation

Bonfim, Diana and Santos, João A. C., The Importance of Deposit Insurance Credibility (July 7, 2020). Available at SSRN: https://ssrn.com/abstract=3674147 or http://dx.doi.org/10.2139/ssrn.3674147

Diana Bonfim (Contact Author)

Banco de Portugal ( email )

Av Almirante Reis, 71
P-1150-012 Lisboa
Portugal

Catholic University of Portugal (UCP) - Catolica Lisbon School of Business and Economics ( email )

Palma de Cima
Lisbon, 1649-023
Portugal

João A. C. Santos

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-5583 (Phone)
212-720-8363 (Fax)

HOME PAGE: http://HTTP://WWW.NEWYORKFED.ORG/RMAGHOME/ECONOMIST/SANTOS/CONTACT.HTML

New University of Lisbon - Nova School of Business and Economics ( email )

Campus de Campolide
Lisbon, 1099-032
Portugal

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