Alexei Karas (University College Roosevelt): Deposit Insurance, Market Discipline and Bank Risk

Alexei Karas (University College Roosevelt, Middelburg, the Netherlands): Deposit Insurance, Market Discipline and Bank Risk

Co-authors: Koen Schoors (Ghent University) and William Pyle (Middlebury College)

Abstract

Using evidence from Russia, we explore the effect of deposit insurance on multiple measures of bank risk. Drawing on bank-level variation in the ratio of deposits held by households and firms, so as to isolate the change in market discipline after the introduction of deposit insurance, we demonstrate that banks for which the decline in market discipline was relatively large were more likely to experience a greater subsequent increase in traditional measures of risk and a greater subsequent rate of failure. These results are robust to the inclusion of time-varying bank-specific controls and bank-level fixed effects. Moreover, they hold in a difference-in-difference setting in which state and foreign-owned banks, whose deposit insurance regime does not change over the period of analysis, serve as a control.

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