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Deposit Insurance, Banking Crises, and Market Discipline: Evidence from a Natural Experiment on Deposit Flows and Rates

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Abstract

Using evidence from Russia, we carry out what we believe to be the literature's cleanest test of the direct impact of deposit insurance on market discipline and study the combined effect of a banking crisis and deposit insurance on market discipline. We employ a difference-in-difference estimator to isolate the change in the behavior of a newly insured group (i.e., households) relative to an uninsured “control” group (i.e., firms). The sensitivity of households to bank capitalization diminishes markedly after the introduction of deposit insurance. The traditional wake-up call effect of a crisis is muted by this numbing effect of deposit insurance.

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