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Deposit insurance, bank exit, and spillover effects

Yang Ji, Wenlong Bian and Yiping Huang

Journal of Banking & Finance, 2018, vol. 96, issue C, 268-276

Abstract: This study resolves a puzzle in the banking literature: why do an increasing number of countries adopt a deposit insurance scheme (DIS) while prior studies have shown that it increases the likelihood of banking crises? Using a dataset of 64 countries over the period 1970–2009, our study shows that the adoption of a DIS is associated with a 2.0–4.7 percentage points higher likelihood of banking crises (the “direct effect”), while it is associated with a 10.1–11.1 percentage points lower likelihood of non-banking financial crises (the “spillover effect”). Since the “spillover effect” is larger than the “direct effect”, a DIS actually increases overall financial stability. Additionally, we analyze the mechanisms through which a DIS affects financial crises. First, we highlight the existence of the implicit guarantee and examine its interaction with an explicit DIS. Second, we investigate the substitution effect between banking crises and non-banking crises.

Keywords: Deposit insurance; Implicit guarantee; Bank exit; Direct effect; Spillover effect (search for similar items in EconPapers)
JEL-codes: E44 G21 G28 (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:eee:jbfina:v:96:y:2018:i:c:p:268-276