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The Impact of Explicit Deposit Insurance on Market Discipline

Vasso Ioannidou () and Jan de Dreu ()

DNB Working Papers from Netherlands Central Bank, Research Department

Abstract: This paper studies the impact of explicit deposit insurance on market discipline in a framework that resembles a natural experiment. We improve upon previous studies by exploiting a unique combination of country-specific circumstances, design features, and data availability that allows us to distinguish between demand and supply effects. We show that deposit insurance causes a significant reduction in market discipline. We also show that the effect of deposit insurance depends on the coverage rate. When the coverage rate is more than 60 percent, market discipline is significantly reduced and it is completely eliminated when the coverage rate reaches 100 percent. Our results also suggest that most market discipline comes from large depositors and that the introduction of deposit insurance affected mainly those who were already active in imposing discipline. Our findings emphasize the need for binding coverage limits per depositor, high degrees of co- insurance, and "tailor made" deposit insurance systems that preserve the incentives of a critical mass of depositors that are willing and able to perform this function.

Keywords: Market Discipline; Deposit Insurance; Deposit Insurance Coverage. (search for similar items in EconPapers)
JEL-codes: F30 F41 G14 G21 G28 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin, nep-fmk and nep-ias
Date: 2006-02
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (23) Track citations by RSS feed

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Working Paper: The Impact of Explicit Deposit Insurance on Market Discipline (2006) Downloads
Working Paper: The impact of explicit deposit insurance on market discipline (2005)
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Persistent link: https://EconPapers.repec.org/RePEc:dnb:dnbwpp:089

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