Deposit insurance systems and bank risk

Abstract

The link from deposit insurance to bank risk taking has been widely analysed, but has been the subject of relatively little empirical work. This work contributes to the existing literature by exploring microeconomic aspects of the deposit insurance–bank risk relationship. It employs four of the five IMF core financial soundness indicators, using data from financial statements for 914 banks in 64 countries. It also disaggregates deposit insurance by individual design features. Results, generated using GMM, suggest that deposit insurance mainly affects bank risk through its relationship with profitability and asset quality. An optimal deposit insurance system might have features such as voluntary membership, no cover for foreign currency deposits, no coinsurance, be unfunded, and administered by a private sector manager with the insurance cost borne fully by the private sector.