Deposit Insurance,Bank Market Discipline And Bank Risk

As of October 2015,China does not limit the deposit interest rate of banks.At the same time,the scale of China's shadow banking is very large and non-performing loan ratio is high,so it is important to prevent increasing bank risk and hold fast to the base line of does not encountering systemic risk.To prevent increasing bank risk in the period when interest rate liberalization is speeded up,large shadow banking is growing rapidly and non-performing loan ratio is high,an explicit deposit insurance system was introduced to cover all depository financial institutions in China on May 1,2015.Although the deposit insurance helps to ensure fair competition among banks,protect the interests of depositors and reduce bank runs caused by risk contagion,it also tends to decrease market discipline,induce moral hazard problems and leads to an increase in bank risk.Based on China's unique institutional background and bank characteristics,we firstly explore the effect of the deposit insurance on bank market discipline.Then,we discuss the relation between the deposit insurance and bank risk,including bank idiosyncratic risk and bank systemic risk.Finally,we explore the possible underlying channels of the effect of deposit insurance on bank risk.In the early implementation of the deposit insurance system,it is important to study how to promote incentive compatibility between the deposit insurance and bank market discipline and how to effectively prevent the moral hazard caused by the deposit insurance.This study contributes to the existing literature in several ways.First,we explore the effect of the deposit insurance on bank market discipline based on China's unique institutional background.According to the characteristics of China's banks taking deposits,enterprise deposits do not respond to bank risk taking.So we study the degree to which depositors actually engage in market discipline according to the household's behaviors using the collated data of household deposits and wealth management products.We test the effectiveness of bank market discipline in China thoroughly using the specific data.Further,a deposit insurance scheme was introduced to cover all household deposits in China's banks while wealth management products were left uncovered in 2015.We compare the responsiveness of household deposits and wealth management products to bank risk taking using the method of difference-in-differences(DID)model.Based on the differentiated protection of household deposits and wealth management products in the limited deposit insurance system,this paper explores the effect of deposit insurance on market discipline in banking sector.The empirical result shows that household will response to bank risk characteristics such as the ratio of capital to asset and non-performing loan ratio,thus market discipline has significant effect in banking sector before the introduction of the deposit insurance system.Deposit insurance increases wealth management products'risk sensitivity to the ratio of capital to asset and non-performing loan ratio,while it decreases household deposits' risk sensitivity to the two ratios.Finally the growth rate of small-sized banks is higher.Deposit insurance doesn't lead to household moving deposits from small and medium-sized banks to big banks.Second,from the perspective of preventing the moral hazard of explicit deposit insurance in the non-crisis period,this paper compares the impact of the deposit insurance on bank idiosyncratic risk in China and the United States and discusses the effect of bank leverage and bank governance structure on their relationship.Further,we use difference-in-differences(DID)model to explore the effect of deposit insurance on bank idiosyncratic risk and its mechanism in China based on China's unique institutional background.As some core elements of China's deposit insurance scheme are based on America's success,such as risk-adjusted premiums and risk-minimizing system mandates.This paper compares the impact of the deposit insurance on bank idiosyncratic risk in the two countries.Then based on the novel perspective of bank governance and bank leverage,we examine the institutional factors leading to differentiated relationships between the deposit insurance and bank idiosyncratic risk in the two countries.Moreover as deposit insurance has different effect on the four biggest banks and other banks,we use difference-in-differences(DID)model to study the effect of deposit insurance on other banks' idiosyncratic risk and explore the possible underlying channels.The main finds are as follows.First,explicit deposit insurance significantly increases the individual risk of non-state-owned banks in China,while it has little effect on bank risk in America.Second,the higher bank leverage is and the higher the share of the largest shareholder is,the more serious the moral hazard problem of deposit insurance will be,both in China and in America.More dispersed ownership structure and lower bank leverage offset some of the negative impact of America's deposit insurance on bank individual risk.Third,following the introduction of China's deposit insurance,the idiosyncratic risk,bank leverage and shadow banking of the four biggest banks aren't significantly affected,while non-state-owned banks will raise bank leverage and engage in shadow banking more actively,resulting in higher bank risk.Third,we take the bank interconnectedness structure and market capitalization of each bank into consideration in the measurement of systemic risk.Then we furtherly explore the effect of deposit insurance on bank systemic risk and the possible underlying channels.We consider the market capitalization of each bank as well as its connectedness in the measurement of bank systemic risk,which extends the existing analysis just considering the relation between the rate of bank return and the rate of bank system return.Based on the measurement of bank systemic risk,we study the relationship between the deposit insurance and bank systemic risk in China,which remedies the research in accordance with the China's unique institutional practice.Then we discuss the effect of the deposit insurance on bank management behavior and try to give a clear and correct understanding of the underlying mechanism of the relation between the deposit insurance and bank systemic risk.We find that explicit deposit insurance significantly increases the systemic risk of non-state-owned banks in China.And following the introduction of China's deposit insurance,non-state-owned banks will engage in non-interest income generating activities and shadow banking more actively,resulting in higher bank systemic risk.Making use of the implementation of China's deposit insurance system from 2015,we explore the effect of the deposit insurance on bank market discipline.Then,we discuss the relation between the deposit insurance and bank risk,including bank idiosyncratic risk and bank systemic risk.Finally,we explore the possible underlying channels of the effect of deposit insurance on bank risk.Our research is helpful to improve China's deposit insurance system and bank regulation,leading to more stable financial system.