Deposit Insurance, Risk-Taking and Banking Crises: Is there a Risk-Minimizing Level of Deposit Insurance Coverage?

49 Pages Posted: 5 Nov 2008

See all articles by Apanard Penny Prabha

Apanard Penny Prabha

University of Illinois at Springfield

Clas Wihlborg

Chapman University; University West

Date Written: November 4, 2008

Abstract

Explicit deposit insurance is a two-edged sword with respect to risk taking. High explicit coverage creates incentives to shift risk to a deposit insurance fund or taxpayers; low explicit coverage may be associated with strong implicit insurance reflecting lack of credibility of non-insurance. Institutions that allow banks to fail without serious contagion effects enhance this credibility. Alternative measures of banks' risk taking are used to test the hypothesis expressed as a U-shaped relationship between explicit coverage and risk taking. The hypothesis is strongly supported when the occurrence of banking crises and non-performing loans are proxies for risk-taking in a country's banking system. Institutional characteristics affect the relation between explicit coverage and risk-taking.

Keywords: Deposit Insurance, Risk-taking, Risk-shifting, Market Discipline, Banking Crises

JEL Classification: G21, G28, F43

Suggested Citation

Prabha, Apanard Penny and Wihlborg, Clas, Deposit Insurance, Risk-Taking and Banking Crises: Is there a Risk-Minimizing Level of Deposit Insurance Coverage? (November 4, 2008). Available at SSRN: https://ssrn.com/abstract=1295452 or http://dx.doi.org/10.2139/ssrn.1295452

Apanard Penny Prabha

University of Illinois at Springfield ( email )

Springfield, IL 62703
United States

Clas Wihlborg (Contact Author)

Chapman University ( email )

333 N. Glassell
Orange, CA 92866
United States
+17147447630 (Phone)

University West ( email )

Trollhättan, 46186
Sweden

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