Does deposit insurance improve financial intermediation? Evidence from the Russian experiment

This study examines how the introduction of deposit insurance affects depositors and banks, using the deposit-insurance scheme introduced into the Russian banking system as a natural experiment. The fundamental research question is whether the introduction of deposit insurance leads to a more effective banking system as evidenced by increased deposit-taking and decreased reliance upon State-owned banks as custodians of retail deposits. We find that banks entering the new deposit-insurance system increase both their level of retail deposits and their ratios of retail deposits to total assets relative to banks that do not enter the new deposit insurance system. These results hold up in a multivariate panel-data analysis that controls for bank- and time-random effects. The longer a bank has been entered into the deposit insurance system, the greater is its level of deposits and its ratio of deposits to assets. Moreover, this effect is stronger for regional banks and for smaller banks. We also find that implementation of the new deposit-insurance system has the effect of “leveling the playing field” between State-owned banks and privately owned banks. Finally, we find strong evidence of moral hazard following implementation of deposit insurance in the form of increased bank risk-taking. Financial risk and, to a lesser degree, operating risk increase following implementation.     

The effect of industry consolidation and deposit insurance reform on the resiliency of the U.S. bank insurance fund

We examine the effects of structural change in the U.S. banking industry, as well as key regulatory changes, including recently enacted deposit insurance reform legislation, on the resiliency of the FDIC-administered bank insurance fund (BIF) by estimating and comparing the probability of BIF insolvency over time. We do this using a Markov-switching model that relies on historical patterns of BIF disbursements to define the probability of switching among three “states” of the banking industry's financial health. Monte Carlo simulations are then performed to project the financial condition of the BIF over a 50-year period. Our results indicate that the insolvency risk to the bank insurance fund has increased significantly due to industry consolidation, and is mainly due to the concentration of deposits in the 10 largest U.S. banking companies. We also find that recent deposit insurance reforms will cause only a marginal reduction in the risk of BIF insolvency. The increased risk associated with a more concentrated industry structure simply dominates the reform effect.     

Market discipline and deposit insurance reform in Japan

On April 1, 2002, the Japanese government lifted a blanket guarantee of all deposits and began limiting the coverage of time deposits. This paper uses this deposit insurance reform as a natural experiment to investigate the relationship between deposit insurance coverage and market discipline. I find that the reform raised the sensitivity of interest rates on deposits, and that of deposit quantity to default risk. In addition, the interest rate differentials between partially insured large time deposits and fully insured ordinary deposits increased for risky banks. These results suggest that the deposit insurance reform enhanced market discipline in Japan. I also find, however, that too-big-to-fail (TBTF) policy became a more important determinant of interest rates and deposit allocation after the reform, thereby partially offsetting the positive effects of the deposit insurance reform on overall market discipline.     

Deposit Insurance, Moral Hazard and Market Monitoring

The paper analyses the relationship between deposit insurance, debt-holder monitoring, and risk taking. In a stylised banking model we show that deposit insurance may reduce moral hazard, if deposit insurance credibly leaves out non-deposit creditors. Testing the model using EU bank level data yields evidence consistent with the model, suggesting that explicit deposit insurance may serve as a commitment device to limit the safety net and permit monitoring by uninsured subordinated debt holders. We further find that credible limits to the safety net reduce risk taking of smaller banks with low charter values and sizeable subordinated debt shares only. However, we also find that the introduction of explicit deposit insurance tends to increase the share of insured deposits in banks' liabilities.     

Collateralization,leverage, and stressed expected loss

We describe a general equilibrium model with a banking system in which the deposit bank collects deposits from households and the merchant bank provides funds to firms. The merchant bank borrows collateralized short-term funds from the deposit bank. In an economic downturn, as the value of collateral decreases, the merchant bank must sell assets on short notice, reinforcing the crisis, and defaults if its cash buffer is insufficient. The deposit bank suffers from losses because of the depreciated assets. If the value of the deposit bank's assets is insufficient to cover deposits, it also defaults. Deposits are insured by the government, with a premium paid by the deposit bank equal to its expected loss on the deposits. We define the bank's capital shortfall in the crisis as the expected loss on deposits under stress. We calibrate the model on the U.S. economy and show how this measure of stressed expected loss behaves for different calibrations of the model. A 40% decline of the securities market would induce a loss of 12.5% in the ex-ante value of deposits.     

The spread of deposit insurance and the global rise in bank asset risk since the 1970s

We construct a new measure of deposit insurance generosity for many countries, empirically model the exogenous international influences on the adoption and generosity of deposit insurance and use a novel econometric method to explore the causal chain from the expansion of deposit insurance generosity to increased overall lending, increased lending to households, increased banking system leverage, and more severe and frequent banking crises. Greater deposit insurance generosity robustly produces greater overall lending relative to bank assets and more lending to households relative to both bank assets and GDP, and results in higher banking system leverage. Our estimates, however, are not conclusive regarding whether greater deposit insurance generosity resulted in greater total loans relative to GDP or in more frequent or severe banking crises.     

Private deposit insurance,deposit flows,bank lending,and moral hazard

We examine the role of private unlimited deposit insurance as a complement to federal deposit insurance for deposit flows, bank lending, and moral hazard during a crisis. We find that banks whose deposits are federally and privately fully insured obtain more deposits and expand lending, in contrast to banks whose deposits are only federally insured. We also document that privately insured banks remain prudent in the loan origination process during the subprime crisis. Our results offer novel insights into depositor and bank behavior in the presence of multiple deposit insurance schemes with differential design features. They also illustrate how private sector solutions incentivize prudent bank behavior to strengthen the financial safety net.     

Financial Intermediaries and Liquidity Creation

Trading losses associated with information asymmetries can be mitigated by designing securities which split the cash flows of underlying assets. These securities, which can arise endogenously, have values that do not depend on the information known only to informed agents. Bank debt (deposits) is an example of this type of liquid security which protect relatively uninformed agents, and we provide a rationale for deposit insurance in this content. High-grade corporate debt and government bonds are other examples, implying that a money market mutual fund-based payments system may be an alternative to one based on insured bank deposits.     

Capital Structure, Agency Problems, and Deposit Insurance in Banking Firms

This paper applies and synthesizes various theories of corporate finance, including capital structure, agency insurance, and regulation, to the case of banking firms and the deposite insurance system. It is argued that a value-maximizing bank would reach its optimal capital structure by minimizing the agency costs of incentive conflicts among stockholders, managers, uninsured depositors, and the deposit insurance agency. Although a regulatory imposed capital requirment may reduce the agency costs inherent in the insurance contact, it cannot produce a universal capital structure that is optimal for all insured banks. The observed capital structure patterns also suggest that banks actively seek an optimal capital structure.     

Deposit Insurance, Capital Adequacy Requirements and Interest Rate Dynamics

This paper examines the long run interaction among deposit insurance, bank deposit rates and capital adequacy requirements. Using analysis similar to the price discrimination model of Lott and Roberts (1991) we find that a competitive environment among banks would link the spread between insured and uninsured deposit rates to the size of the insurance premium. We also find that banks that choose to operate at the regulatory minimum capital level, would increase asset risk with increased capital requirements if (1) the implicit interest paid to insured and uninsured depositors is equally sensitive to changes in risk and capital adequacy and (2) the insurance premium is independent of the level of risk and capital adequacy. Under the present risk-based premium structure, asset risk has the potential to decline when the regulatory agency raises capital requirements. Finally, we examine the time series behavior of insured and uninsured interest rates to see if it is consistent with our theoretical model. We find that insured and uninsured rates, along with deposit insurance premiums, are cointegrated series as suggested by our model.     

A positive analysis of deposit insurance provision: Regulatory competition among European Union countries

We consider the provision of deposit insurance as the outcome of a non-cooperative policy game between nations. Nations compete for deposits in order to protect their banking systems from the destabilizing impact of potential capital flight. Policies are chosen to attract depositors who optimally respond to the expected return to deposits, which depends on deposit insurance levels, systemic risk and transaction costs. We identify both defensive and beggar-thy-neighbour policies. The model sheds light on the European banking crisis of 2008 in which individual nations ratcheted up their deposit insurance levels.     

Deposit Insurance,Banking Crises,and Market Discipline: Evidence from a Natural Experiment on Deposit Flows and Rates

Using evidence from Russia, we carry out what we believe to be the literature's cleanest test of the direct impact of deposit insurance on market discipline and study the combined effect of a banking crisis and deposit insurance on market discipline. We employ a difference‐in‐difference estimator to isolate the change in the behavior of a newly insured group (i.e., households) relative to an uninsured “control” group (i.e., firms). The sensitivity of households to bank capitalization diminishes markedly after the introduction of deposit insurance. The traditional wake‐up call effect of a crisis is muted by this numbing effect of deposit insurance.     

Australia's Implicit Deposit Insurance — Should It Be Reconsidered?

Most major developed countries have bank deposit insurance; the European Parliament recently mandated it for all member countries. One of the characteristics of most deposit insurance schemes to protect depositors is that the banking industry funds the scheme through assessments. Interestingly, Australia does not have explicit deposit insurance and to date there has been little public debate on this subject. This paper proposes that such a debate should be initiated.     

The pricing of deposit insurance considering bankruptcy costs and closure policies

The paper aims to study the pricing issue of deposit insurance with explicit consideration of bankruptcy costs and closure policies. Full coverage from deposit insurance is imposed by many regulators to stabilize the banking system in the current financial crisis, despite of the potential moral hazard problems. We argue that bankruptcy cost is an important factor in pricing deposit insurance, especially when the insured institution is insolvent. Applying the isomorphic relationship between deposit insurance and put option, we first derive a closed-form solution for the pricing model with bankruptcy costs and closure policies. Then, we modify the barrier option approach to price the deposit insurance in which the bankruptcy cost is set as a function of asset return volatility and more realistic closure policies considering possible forbearance can be accounted for. The properties of the models are supported by numerical simulations and are consistent with the risk-based pricing scheme.     

AN EMPIRICAL ANALYSIS OF INSURED PORTFOLIO STRATEGIES USING LISTED OPTIONS

Theoretical rationale for the purchase or sale of portfolio insurance has been developed in prior works, but the relative preference structure for insured portfolios has not been examined empirically. This paper provides empirical evidence about performance of insured portfolios constructed from listed put and call options, their underlying stocks, and treasury bills. Efficient portfolios are identified using rules of stochastic dominance and stochastic dominance with a riskless asset from randomly created portfolios. The results illustrate the importance of put and call options to create portfolios containing an insurance component, since insured portfolios represent the majority of dominant assets.     

中国居民资产配置趋势及商业银行对策

从近年来中国居民金融资产变化情况来看,在金融资产总量急剧增加的同时,资产结构也由原来单一的银行资产向多元化方向发展,但储蓄存款仍居主导地位,人均居民金融资产水平也较低。后危机时期居民金融资产总量增长空间仍然较大,资产多元化趋势将更加明显,这意味着储蓄存款将持续减少,而证券、基金、保险、信托、银行理财产品等新型金融产品的投资将日益扩大,居民资产配置以储蓄为主的格局仍将持续较长时间。这为商业银行发展带来两个机遇:一是为商业银行实现经营转型带来了发展机遇;二是为商业银行个人资产管理业务带来了发展机遇。     

Diversification and the cost of debt of bank holding companies

In this study, we investigate the relationship between various dimensions of diversification and the cost of debt for publicly traded bank holding companies (BHCs). We find that both domestic geographic diversification of deposits and diversification of assets lead to a lower bond yield-spread. Diversification of non-traditional banking activities leads to a lower cost of debt only when yield-spread and diversification are estimated simultaneously. In addition, we find that medium-sized BHCs experience a greater reduction in bond yield-spread than small-sized and large-sized BHCs. This is consistent with the too-big-to-fail (TBTF) effects in the banking industry. Furthermore, we document that the association between diversification and yield-spread is bidirectional with higher yield-spreads being associated with greater asset and activity diversification and lower geographic deposit dispersion. The effect of diversification on bond yield-spread is robust after accounting for cross-sectional and serial correlation, and the endogeneity of diversification.     

What is the effect of unconventional monetary policy on bank performance?

This paper examines the relationship between unconventional monetary policy and the US banking performance. Unconventional monetary policy is captured through the central bank's assets and excess reserves. Results show that unconventional monetary policy has a negative relationship with bank performance. Further analysis shows that the negative association between unconventional monetary policy and performance is mitigated for banks with a high level of asset diversification and low deposit funding. We also find that the negative relationship between unconventional monetary policy and performance subdues for deposit insured financial institutions. Finally, we use dynamic panel threshold analysis which reveals that the negative association between unconventional monetary policy and bank performance is particularly pronounced above the reported threshold value.     

Deposit insurance and subsidized recapitalizations

The 2007–2009 financial crisis saw a vast expansion in deposit insurance guarantees around the world and yet our understanding of the design and consequences of deposit insurance schemes is in its infancy. We provide a new rationale for the provision of deposit insurance. In our model the banking sector exhibits both adverse selection and moral hazard, which implies that the social benefits of bank monitoring must for incentive reasons be shared between depositors and banks. Consequently, socially too few deposits are made in equilibrium. Deposit insurance – or, equivalently, bank recapitalization – corrects this market failure. We find that deposit insurance should be funded not by banks or depositors but out of general taxation. The optimal level of deposit insurance varies inversely with the quality of the banking system. Hence, when the soundness of the financial sector is uncertain, governments should consider supporting deposit insurance schemes and undertaking subsidized recapitalizations.     

限额存款保险与中国银行业的市场约束

一般认为,限额存款保险制度让存款人的资产部分地暴露于风险之中,从而市场约束虽然比无保险状态下较弱但仍然有效,因此世界上实行存款保险制度的国家多采用限额保险。本文认为,中国银行业特殊的股权结构,以及长期以来政府对大银行的资金支持形成了存款人规模偏好和银行大而不倒(too big to fail)的预期;这一预期特征必将异化市场约束,进而导致银行陷入无序的规模竞争并激励其风险承担;如果单纯实施限额存款保险制度,非但不能修正中国商业银行市场约束的异化问题,而且将强化公众的大而不倒预期,使市场约束面临更严重的扭曲。