Deposit Insurance and Bank Intermediation in the Long Run

50 Pages Posted: 20 Sep 2007

See all articles by Robert Cull

Robert Cull

World Bank - Development Research Group (DECRG)

Marco Sorge

World Bank Group - International Finance Corporation

Lemma W. Senbet

University of Maryland - Robert H. Smith School of Business

Date Written: July 2004

Abstract

This paper provides empirical evidence on the impact of deposit insurance on the growth of bank intermediation in the long run. We use a unique dataset capturing a variety of deposit insurance features across countries, such as coverage, premium structure, etc. and synthesize available information by means of principal component indices. This paper specifically addresses sample selection and endogeneity concerns by estimating a generalized Tobit model both via maximum likelihood and the Heckman 2-step method. The empirical construct is guided by recent theories of banking regulation that employ an agency framework. The basic moral hazard problem is the incentive for depository institutions to engage in excessively high-risk activities, relative to socially optimal outcomes, in order to increase the option value of their deposit insurance guarantee. The overall empirical evidence is consistent with the likelihood that generous government-funded deposit insurance might have a negative impact on the long-run growth and stability of bank intermediation, except in countries where the rule of law is well established and bank supervisors are granted sufficient discretion and independence from legal reprisals. Insurance premium requirements on member banks, even when risk-adjusted, are instead found to have little effect in restraining banks' risk-taking behavior.

Keywords: Deposit Insurance, Moral Hazard, Bank Regulation and Supervision, Financial development

JEL Classification: G2, O1, F3

Suggested Citation

Cull, Robert and Sorge, Marco and Senbet, Lemma W., Deposit Insurance and Bank Intermediation in the Long Run (July 2004). BIS Working Paper No. 156, Available at SSRN: https://ssrn.com/abstract=782325 or http://dx.doi.org/10.2139/ssrn.782325

Robert Cull (Contact Author)

World Bank - Development Research Group (DECRG) ( email )

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HOME PAGE: http://econ.worldbank.org/staff/rcull

Marco Sorge

World Bank Group - International Finance Corporation ( email )

2121 Pennsylvania Avenue, NW
Washington, DC 20433
United States

Lemma W. Senbet

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
301-405-2242 (Phone)
301-405-0359 (Fax)

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