Deposit Insurance, Risk-Taking and Banking Crises: Is there a Risk-Minimizing Level of Deposit Insurance Coverage?
49 Pages Posted: 5 Nov 2008
Date Written: November 4, 2008
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: Suggested Citation