Empirical Analysis:
In this section various empirical findings will be consulted which will assist in answering the question proposed in the opening and this will commerce with a paper by Demirgűc-Kunt and Detragiache [2000], which then continues through to another paper by Demirgűc-Kunt and Kane [2001]. These two papers analyse deposit insurance around the globe using econometric models and provides a good foundation to the remaining of this study. Thereafter a paper by Gropp and Vesala [2004] will be considered which concentrates on the EU’s deposit insurance and banking stability.
The authors Demirgűc-Kunt and Detragiache [2000] use cross-sectional data on 61 countries from 1980–1997 and highlight some critical points which indicate that with the presence of explicit deposit insurance bank stability tends to be unfavourable due to deregulated bank interest rates. However if this point is inverted this then means that in developed institutes where careful regulation and supervision is provided, bank stability is unaffected. In-addition it was also found that when coverage was increased to unlimited coverage and also included foreign currency, interbank deposits and actual share of deposit, bank stability became a lot more fragile. Therefore it is possible for one to conclude that in environments where institutional weakness is present banking stability is affected by deposit insurance and this may be the case for developing and emerging economies. Furthermore by increasing the coverage offered to depositors it becomes clearly evident that banking stability is once again destabilised, however this seems to be the case when schemes are funded by the government as apposed to private organisations.
Moving over to the study conducted by Demirgűc-Kunt and Kane [2001] they examine cross country differences in deposit insurance design and their affects on bank stability. According to the authors they find results empirically significant and in support of the results found by Demirgűc-Kunt and Detragiache [2000]. They find that when institutes reside in weak environments where deposit insurance arrangements are poorly designed there is the increased tendency and probability for bank instability and future crises.
This proposition can be confirmed when the frequency of bank crises around the world is considered and it is statistically been proven by Demirgűc-Kunt and Kane [2001] that where explicit deposit insurance is inadequately designed crisis are often quite high. In-addition to frail environments it has also been flagged that those countries with poor contracting environments also have the tendency to suffer from banking instability. The principle reason is that the regulations and supervision of such countries will not be fully developed, and with a partially developed banking structure it is relatively impossible to impose property rights and contract enforcement which would allow for information to be provided to its depositors in a timely manner to limit banking instability.
As a result of these empirical findings it is possible to express that in countries with poor supervision, regulation and contracting, deposit insurance invites bank to exploit the weakness in supervision and increase the amount of risky projects they take on and this is once again in equivalence to the findings of Kane [1989] and Demirgűc-Kunt and Detragiache [2000].
Now turning to the EU and utilising the study conducted by Gropp and Vesala [2004] to answer the question proposed it is found that the author’s empirical findings are quite striking since they provided conflicting result to the ones already provided when econometrics analysis using data on all banks in 15 EU is conducted which is supported by their findings.
It is argued and statistically been proven that with the presence of credible explicit deposit insurance relative to implicit safety net moral hazard and banking crises are considerable reduced if subordinated debt liabilities share is comparatively high. Also with the presence of a credible explicit deposit insurance many large depositors and creditors all together are left out as the coverage per depositor is limited. As a result of this subordinated debt limits moral hazard and excessive risk-taking of banks and therefore increasing bank stability. Additionally if banks have high chartered values then they will be less inclined to make adjustments to the amount of risk they take with the presence of deposit insurance since this can be considered as the case of “Too Big To Fail” for large systematic Banks. It is also important to note that elevated charter values operate as prevention against additional risk taking in-comparison to banks with low charter values. In light of the point of “Too Big To Fail” it has been found that regardless of whether explicit deposit insurance is introduced or not if the bank being tested forms part of a particularly large banking systems in a given country within the EU their risk taking will remain unaffected and restriction on the limit of the safety net to depositor is only plausible for smaller banking institutes.
Therefore it can be seen that with the presence of explicit deposit insurance within the EU risk taking which increases the probability of bank default which will then cause bank instability has been reduced. It can also be seen that this effect is less common in the case of where banks have larger charter value than smaller banks. Large banks which are considered as fundamental parts of the banking system will more often that not carry on with their daily practises regardless of the creditability of deposit insurance.
Conclusion:This study analysed the relationship between deposit insurance and possible link with Bank Stability around the globe and EU. It was found that there are some conflicting results when previous literature is considered which finds that deposit insurance increases moral hazards which would result in bank stability being affected due to banks increasing there risk-taking as found by Demirgűc-Kunt and Detragiache [2000], and Demirgűc-Kunt and Kane [2001] and even Grossman [1992] if more historical data is examined. However a crucial point to bear in mind is the fact that studies conducted by Demirgűc-Kunt and Detragiache [2000], and Demirgűc-Kunt and Kane [2001] comprised of data which incorporated developing and emerging markets. In accordance with these studies environments where there is institutional weakness which includes partially developed banking regulations and supervision and also poor contracting laws deposit insurance does not aid banking stability but also increase moral hazards. However in the case of developed countries the establishment of explicit deposit insurance may considerably reduce risk-taking which increase banking stability and can also prevent systematic banks runs. Furthermore more the presence of explicit deposit insurance systems reduce the scope of safety nets and allows governments or bank authorities to exclude some creditors from the safety net.
However one must take into consideration that deposit insurance itself can not stabilise banks without the assistance of credible limits on safety nets, developed banking regulations and supervision arrangement along side sound contracting environments. Therefore it is possible to safely state that deposit insurance aids to banking stability, however if the point mentioned above are not adhered to bank stability could be adversely affected with the presence of deposit insurance.
References:
Deposit Insurance Around The Globe: Where Does It Work
Asli Demirguc-Kunt and Edward J Kane 2001
World Bank and Boston College
Deposit Insurance And International Bank Deposit
Harry Huizinga European Commission, Tilburg University and CEPR and
Geatan Nicodeme European Commission and Solvay Business School
2002
European Commission, Tilburg University and CEPR
Deposit Insurance and Lending of Last Resort
France Bruni and Christian de Boissieu 2000
Société Universitaire Européenne de Recherches Financières Amsterdam
Deposit Insurance: Do We Need It and Why?
Antony Santomero
The Wharton School University Of Pennsylvania
Financial Institute Center
Does Deposit Insurance Increase Banking System Stability? An Empirical Investigation
Asli Demirguc-Kunt, and Enrica Detragiache, 2000
World Bank
Deposit Insurance, Moral Hazard and Market Monitoring
Reint Gropp and Jukka Vesala
2004
European Central Bank
Deposit Insurance, Regulation, and Moral Hazard in the Thrift Industry
Grossman, R. 1992
American Economic Review
Strengthening Financial Infrastructures
Richard Dale 2000
Société Universitaire Européenne de Recherches Financières Amsterdam
The S&L Insurance Mess: How Did it Happen?
Edward J Kane, 1989
(Washington Urban Institute Press)
To see the document in full with results and the data set used Does Deposit Insurance Increase Banking System Stability An Empirical Investigation should be consulted
To see the document in full with results Deposit Insurance around the Globe: Where Does It Work? Should be consulted.
To see the document in full with results Deposit Insurance, Moral Hazard and Market Monitoring should be consulted.
