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How does deposit insurance affect bank risk ? evidence from the recent crisis, Volume 1
 
Author:Anginer, Deniz; Demirguc-Kunt, Asli; Zhu, Min; Country:World;
Date Stored:2012/12/11Document Date:2012/12/01
Document Type:Policy Research Working PaperSubTopics:Bankruptcy and Resolution of Financial Distress; Emerging Markets; Banks & Banking Reform; Debt Markets; Deposit Insurance
Language:EnglishMajor Sector:Finance
Rel. Proj ID:1W-The Crisis And Beyond: Fy11-Fy13 -- -- P122136;Region:The World Region
Report Number:WPS6289Sub Sectors:General finance sector
Collection Title:Policy Research working paper ; no. WPS 6289Volume No:1

Summary: Deposit insurance is widely offered in a number of countries as part of a financial system safety net to promote stability. An unintended consequence of deposit insurance is the reduction in the incentive of depositors to monitor banks, which leads to excessive risk-taking. This paper examines the relation between deposit insurance and bank risk and systemic fragility in the years leading to and during the recent financial crisis. It finds that generous financial safety nets increase bank risk and systemic fragility in the years leading up to the global financial crisis. However, during the crisis, bank risk is lower and systemic stability is greater in countries with deposit insurance coverage. The findings suggest that the "moral hazard effect" of deposit insurance dominates in good times while the "stabilization effect" of deposit insurance dominates in turbulent times. Nevertheless, the overall effect of deposit insurance over the full sample remains negative since the destabilizing effect during normal times is greater in magnitude compared with the stabilizing effect during global turbulence. In addition, the analysis finds that good bank supervision can alleviate the unintended consequences of deposit insurance on bank systemic risk during good times, suggesting that fostering the appropriate incentive framework is very important for ensuring systemic stability.

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