The Impact of Explicit Deposit Insurance on Market Discipline

CentER Discussion Paper No. 2006-05

40 Pages Posted: 10 Mar 2006  

Vasso Ioannidou

Lancaster University - Management School; Centre for Economic Policy Research (CEPR)

Jan de Dreu

Royal Bank of Scotland (RBS) - Global Banking & Markets

Date Written: January 2006

Abstract

This paper studies the impact of explicit deposit insurance on market discipline in a framework that resembles a natural experiment. We improve upon previous studies by exploiting a unique combination of country-specific circumstances, design features, and data availability that allows us to distinguish between demand and supply effects. We show that deposit insurance causes a significant reduction in market discipline. We also show that the effect of deposit insurance depends on the coverage rate. When the coverage rate is more than 60 percent, market discipline is significantly reduced and it is completely eliminated when the coverage rate reaches 100 percent. Our results also suggest that most market discipline comes from large depositors and that the introduction of deposit insurance affected mainly those who were already active in imposing discipline. Our findings emphasize the need for binding coverage limits per depositor, high degrees of co-insurance, and tailor made deposit insurance systems that preserve the incentives of a critical mass of depositors that are willing and able to perform this function.

Keywords: market discipline, deposit insurance, deposit insurance coverage

JEL Classification: F30, F41, G14, G21, G28

Suggested Citation

Ioannidou, Vasso and Dreu, Jan de, The Impact of Explicit Deposit Insurance on Market Discipline (January 2006). CentER Discussion Paper No. 2006-05. Available at SSRN: https://ssrn.com/abstract=888681 or http://dx.doi.org/10.2139/ssrn.888681

Vasso Ioannidou (Contact Author)

Lancaster University - Management School ( email )

Bailrigg
Lancaster, LA1 4YX
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Jan De Dreu

Royal Bank of Scotland (RBS) - Global Banking & Markets ( email )

135, Bishopsgate
EC2M 3UR London
United Kingdom

Paper statistics

Downloads
429
Rank
53,454
Abstract Views
1,848