Deposit Insurance and Moral Hazard: Does the Counterfactual Matter?

By Reint Gropp, J. Vesala. Social Science Research Network, 2001

133 citations recorded by the source corpus.

The paper analyses the relationship between deposit insurance, debt-holder monitoring, charter values and risk taking. Utilising cross-sectional and time series variation in the existence of deposit insurance schemes in the EU, we find that the establishment of explicit deposit insurance significantly reduces the risk taking of banks. This finding stands in contrast to most of the previous empirical literature. It supports the hypothesis that in the absence of deposit insurance, European banking systems have been characterised by strong implicit insurance operating through the expectation of public intervention at times of distress. We also test further hypotheses regarding the interaction between deposit insurance and monitoring, charter values and 'too-big-to-fail.' We find that smaller banks and banks with lower charter values and more subordinated debt reduce risk taking more after the introduction of explicit deposit insurance, which supports 'too-big-to-fail', monitoring by debt holders and the moral hazard reducing effect of charter values. JEL Classification: G21, G28

Subfields: Finance

View Paper: https://www.semanticscholar.org/paper/8d631d136cead322673cc71f781eb7ca99e42947

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Citations in the corpus

Bank capital buffer and risk adjustment decisions (2011, methodology): “Applying this methodology rather than the three stage least squares (3SLS) approach that is common in this literature(22), allows us to account for possible bank specific effects, providing unbiased estimates.(23) The methodology uses lagged levels as instruments in the first difference equations an”
The Relationship between Liquidity Risk and Credit Risk in Banks (2014, methodology): “This behavior is well-documented in the prior literature, such as Keeley (1990), Corbett and Mitchell (2000), Gropp and Vesala (2001), and Freixas, Parigi and Rochet (2003).”
Bank regulation and risk-taking incentives: An international comparison of bank risk (2005, methodology): “A negative relationship between charter value and risk-taking is also found by Gropp and Vesala (2001) in a sample of EU banks over 1991-1998, and by Konishi and Yasuda (2004) for Japanese banks in the 1990s. restriction of banking activity is negatively associated with bank development and…”