Market Discipline and Financial Safety Net Design

44 Pages Posted: 20 Apr 2016

See all articles by Asli Demirgüç-Kunt

Asli Demirgüç-Kunt

World Bank

Harry Huizinga

Tilburg University - Center for Economic Research (CentER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: November 1999


It is difficult to design and implement an effective safety net for banks, because overgenerous protection of banks may introduce a risk-enhancing moral hazard and destabilize the very system it is meant to protect. The safety net that policymakers design must provide the right mix of market and regulatory discipline - enough to protect depositors without unduly undermining market discipline on banks.

There has been little empirical work on the effectiveness of safety nets designed for banks, for lack of data on safety net design across countries. Demirgüç-Kunt and Huizinga examine cross-country data on bank-level interest expense and deposit growth for evidence of market discipline in individual countries. In addition, using cross-country information on deposit insurance systems, they investigate the impact of explicit deposit insurance (and its key features) on bank interest rates and market discipline.

They find that: · Many countries retain some degree of market discipline, regardless of the type of safety net. · The existence of explicit deposit insurance lowers banks' interest expenses and makes interest payments less sensitive to bank risk factors, especially bank liquidity. · Higher explicit coverage, broader coverage, and the existence of an earmarked insurance fund increase required-deposit rates and reduce market discipline. · Government provision of funds lowers deposit rates but also reduces market discipline. · Private (especially joint) management of insurance schemes lowers deposit rates and improves market discipline.

This paper - a product of Finance, Development Research Group - is part of a larger effort in the group to study deposit insurance. The authors may be contacted at or

Suggested Citation

Demirgüç-Kunt, Asli and Huizinga, Harry, Market Discipline and Financial Safety Net Design (November 1999). Available at SSRN:

Asli Demirgüç-Kunt (Contact Author)

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

Harry Huizinga

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
+31 13 466 2623 (Phone)
+31 13 466 3042 (Fax)

Centre for Economic Policy Research (CEPR)

United Kingdom