Bank credit default swaps and deposit insurance around the world |
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| Institution: | 1. College of Business, Bowling Green State University, 214 Business Administration, Bowling Green, OH 43403;2. College of Economics, Shenzhen University, Nanhai Ave 3688, Shenzhen, Guangdong, China;3. College of Business Administration, University of Missouri-St. Louis, One University Blvd., St. Louis, MO 63121;4. Stuart School of Business, Illinois Institute of Technology, 10 West 35th Street, 18th floor, Chicago, IL 60616;1. Institute of Applied Economics, HEC Montréal, Chemin de la Côte-Sainte-Catherine, Montréal, Québec 3000, Canada;2. Research Department, International Monetary Fund, 700 19th Street, N.W., Washington, DC 20431, USA;3. Department of Economics, North Carolina State University, 2801 Founders Drive, 4102 Nelson Hall, Box 8110, Raleigh, NC 27695-8110, USA;4. Department of Economics, University of Washington, Savery Hall, Box 353330, Seattle, WA 98195, USA;1. Department of Economic Theory, University of Barcelona, Diagonal 696, 08034 Barcelona, Spain;2. Complutense Institute of International Economics, Universidad Complutense, Campus de Somosaguas, 28223 Madrid, Spain;1. Queensland University of Technology, 2 George Street, Brisbane, Australia, 4001;2. University of Tasmania, Centenary East, Grosvenor Street, Hobart, Australia, 7005 |
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| Abstract: | We investigate the impact of deposit insurance schemes on banks' credit risk – a predictor of failure and a key element in the current financial crisis. Unlike most studies, which use balance sheet measurements of risk, we adopt a forward-looking and market-based measure of bank credit risk: the credit default swap (CDS) spread. We find that banks in countries with explicit deposit insurance systems have higher CDS spreads, supporting the “moral hazard” view. The results suggest that deposit insurance design features that lessen the adverse impact are risk-adjusted premium, coinsurance systems, government-established systems, “risk-minimizing” systems, and systems with dual-funding sources. Full coverage appears to stabilize bank risk only during the financial crisis period. More stringent bank regulation, such as capital adequacy regulation and independent supervision, could reduce the undesirable impact of deposit insurance. Deposit insurance seems to help stabilize volatile markets, as evidenced during the financial crisis and in countries with greater market volatility. In addition, we find that the adverse impact of deposit insurance on bank credit risk is more pronounced for banks with low asset quality and low liquidity. |
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