Does Deposit Insurance Increase Banking System ... - World Bank
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Does Deposit Insurance Increase Banking System ... - World Bank

Does Deposit Insurance IncreaseBanking System Stability?An Empirical InvestigationAslı Demirgüç-Kunt andEnrica Detragiache

Objective• Does deposit insurance affect bankstability?• Do differences in design make adifference?• Does the impact of deposit insurance onbank stability depend on the quality ofregulations?

Deposit insurance could• make the financial system morestable by preventing runsBut it could also• decrease stability if it encouragesbank risk-taking (moral hazard)

Sample: Panel data 1980-199761 countries40 crisis episodes• Estimate a logit probability modelof banking crises

A distress episode is defined ascrisis if one of the following holds:• The ratio of non-performing assets to totalassets in the banking system exceeded 10percent;• The cost of the rescue operation was at least2 percent of GDP;• The episode involved a large scalenationalization of banks;• Extensive bank runs took place or emergencymeasures such as deposit freezes, prolongedbank holidays, or generalized depositguarantees were enacted by the government.

Countries with explicit depositinsurance60%50%40%30%20%10%01980 1985 1990 1995 1996 1997

Deposit insurance• Explicit versus implicit• Coverage limit• Scope of coverage (foreigncurrency/interbank deposits)• Coinsurance• Funding• Source of funding• Premiums• Management• Membership

Control variables• GDP growth• Change in terms of trade• Depreciation• Inflation• Real interest• M2/reserves• Credit growth• GDP per capita

Deposit insurance and banking crisesDeposit insurance and risk factors:Deposit Ins. .696*(.397)Growth x Dep. Ins. -.158(.107)Tot Change x Dep. Ins. .003(.037)Rl. Interest x Dep. Ins. .070**(.035)Inflation x Dep. Ins. -.019(.025)M2/Reserves x Dep. Ins. .024**(.011)Depreciation x Dep. Ins. .022*(.013)Credit Gro x Dep. Ins. t-2 -.013(.026)-.166*(.102).069**(.032).024**(.010).013*(.007)GDP/Cap x Dep. Ins. .029(.072)Deposit Ins. & Liberalization .997***(.292)

Deposit insurance design features and banking crises:Variations in coverageDeposit insurance design featuresNo coinsurance .397**(.204)(1) (2) (3) (4) (5)Unlimited explicitcoverage.699***(.272)Explicit coveragelimit.019***(.006)Foreign currencydeposits covered.471**(.216)Interbank depositscovered.414*(.248)

Deposit insurance design features and banking crises:Variations in fundingDeposit insurance design featuresImplicit/unfunded/funded .454**(.203)(1) (2) (3) (4)Implicit/unfunded/callable/funded.304**(.136)Source of funding .397**(.187)Bank premiums .034(.049)

Deposit insurance design features and banking crises:Variations in management and membershipDeposit insurance design featuresManagement .269**(.134)(1) (2) (3)Official .800**(.419)Joint .617(1.163)Private .297(.881)Membership .663**(.347)

Deposit insurance design andinstitutional qualityGDP perCapitaLaw andOrderContractEnforcementBureaucraticQualityBureaucraticDelayCorruptionDep. Ins. .859**(.470)2.007***(.832)2.624**(1.268)2.566***(.904)2.848**(1.228)2.234**(1.046)Dep. Ins. xInstitutional Var.-.059(.037)-.410**(.180)-1.068**(.517)-.483***(.193)-1.311**(.625)-.516**(.249)

Deposit insurance and banking crises -two stage estimation(1)DepositInsuranceGrowth -.002(.018)Tot change .003(.009)Real Interest .002(.003)Inflation .001(.002)M2/reserves -.000(.000)Depreciation -.000(.002)Credit Gro t-2-.003(.005)GDP/cap .157***(.012)Contagion 4.756***Predicted DepositInsuranceI. Two-Stage Logit II. 2SLS(1.448)(2)BankingCrisis-.148***(.033)-.018(.016).020***(.008).000(.009)-.000(.000).012***(.005).018*(.010)-.141**(.061)2.964**(1.585)(1)DepositInsurance.001(.003).001(.001).001(.001).001(.001)-.000(.000).001(.001).001(.001).032***(.002).690***(.253)(2)BankingCrisis-.007***(.002)-.001(.001).002***(.001).001(.001)-.000(.000).001***(.000).001(.001)-.006**(.002).126**(.065)

Further sensitivity testsMoral hazard .161** .171** .172** .113* .131* .140**Index (.074) (.086) (.081) (.074) (.077) (.076)Banking restrictions .534*(.331)Public ownership -.006(.007)Concentration -1.592*(.920)Capitalization -.068(.063)Diversification 3.8x10 -24 **(1.7x10 -24 )

Results• Explicit deposit insurance tends to increasebank fragility• This is more so where bank interest rates havebeen deregulated and where the institutionalenvironment is weak• Adverse impact of deposit insurance on bankstability tends to be stronger the moreextensive is the coverage offered todepositors, where the scheme is funded, andwhere the scheme is run by the governmentrather than the private sector.

Policy conclusions• We have to be careful about giving a blanketendorsement of explicit deposit insurance schemesfor all developing countries. Explicit depositinsurance displaces market discipline with regulatorydiscipline, and not all developing countries have theinstitutional development to do that effectively.• Certain features of deposit insurance are lessdesirable than others. Higher coverage, broadercoverage, having a funded scheme are bad features.Co-insurance and private management are relativelygood features. Compulsory membership also reducesfragility. In general, elements that introduce marketdiscipline and reduce adverse selection work better.

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