Deposit insurance and moral hazard: does the counterfactual matter?

  • The paper analyses the relationship between deposit insurance, debt-holder monitoring, bank charter values, and risk taking for European banks. 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. Hence the introduction of an explicit system may imply a de facto reduction in the scope of the safety net. This finding provides a new perspective on the effects of deposit insurance on risk taking. Unless the absence of any safety net is credible, the introduction of deposit insurance serves to explicitly limit the safety net and, hence, moral hazard. We also test further hypotheses regarding the interaction between deposit insurance and monitoring, charter values and "too-big-to-fail." We find that banks with lower charter values and more subordinated debt reduce risk taking more after the introduction of explicit deposit insurance, in support of the notion that charter values and subordinated debt may mitigate moral hazard. Finally, large banks (as measured in relation to the banking system as a whole) do not change their risk taking in response to the introduction of deposit insurance, which suggests that the introduction of explicit deposit insurance does not mitigate "too-big-to-fail" problems.

Download full text files

Export metadata

Additional Services

Share in Twitter Search Google Scholar
Author:Reint GroppGND, Jukka Vesala
Parent Title (German):Frankfurt am Main : European Central Bank, 2001
Series (Serial Number):European Central Bank: Working paper series (47)
Publisher:European Central Bank
Place of publication:Frankfurt am Main
Document Type:Working Paper
Date of Publication (online):2014/03/20
Year of first Publication:2001
Publishing Institution:Universitätsbibliothek Johann Christian Senckenberg
Release Date:2014/03/20
Tag:Banking; Deposit Insurance; Moral Hazard; Risk
GND Keyword:Europäische Union; Einlagensicherung; Einlagensicherungsfonds
Page Number:35
© European Central Bank, 2001. All rights reserved. Reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged. The views expressed in this paper do not necessarily reflect those of the European Central Bank.
Institutes:Wirtschaftswissenschaften / Wirtschaftswissenschaften
Wissenschaftliche Zentren und koordinierte Programme / Sustainable Architecture for Finance in Europe (SAFE)
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
Licence (German):License LogoDeutsches Urheberrecht