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Department of Finance, Copenhagen Business School Working Paper Series, Department of Finance, Copenhagen Business School

No 2005-10:
Deposit Insurance Coverage, Credibility of Non-insurance, and Banking Crises

Apanard Angkinand and Clas Wihlborg

Abstract: The ambiguity in existing empirical work with respect to effects of deposit insurance schemes on banks’ risk-taking can be resolved if it is recognized that absence of deposit insurance is rarely credible and that the credibility of non-insurance can be enhanced by explicit deposit insurance schemes. We show that under reasonable conditions for effects on risk-taking of creditor protection in banking, and for effects on credibility of non-insurance of explicit coverage of deposit insurance schemes, there exists a partial level of coverage that maximizes market discipline and minimizes moral hazard incentives for risk-taking in banking. Using both the occurrence of banking crises and non-performing loans in the banking sector as proxies for excessive risk-taking the results strongly support this hypothesis in industrial and emerging market economies. Policy recommendations on the country level require analyses of institutional factors affecting the credibility of non-insurance. In particular, the implementation of effective distress resolution procedures for banks would allow governments to reduce explicit deposit insurance coverage and, thereby, to strengthen market discipline. JEL Classification: G21; G28; F43 Keywords: Deposit Insurance; Banking Crisis; Insolvency Procedures, Market Discipline

Keywords: na; (follow links to similar papers)

JEL-Codes: G01; G21; (follow links to similar papers)

55 pages, January 1, 2007

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