The Migration Effects Of Liquidity In Turning To Explicit Deposit Insurance

The financial innovation emerges in an endless stream and the process of Marketization of Interest Rates continuously push forward, along with which is the more and more complex liquidity allocation pattern in China’s financial system. The transformation to explicit deposit insurance system has become one of the most important supporting policies to prevent liquidity risk and maintain financial stability. Generally speaking, liquidity allocation mechanisms consist of three processes:banks provide liquidity cushion to other economic entities, inter-bank market acts as co-insurance for banks, and the Central bank serve as the lender of last resort and deposit insurance agency offers liquidity insurance. The transformation to explicit deposit insurance system will inevitably result in a dynamic migration effects on the deposit reallocation, due to the risk appetite changes of depositors and heterogeneous risk exposures of financial institutions. In normal times, the explicit deposit insurance system will cause the diversion and reallocation of deposits in heterogeneous banks and non-bank financial institutions; during crisis, it serves to strengthen the "Flight to safety" effect, which means the deposit will not only flow from non-bank financial institutions to banks, but also rearrange in heterogeneous banks. Empirical data from international and domestic financial institutions shows that, under the background of deposit insurance, the savings, in normal times, move mostly away from large banks to small and medium-sized, even non-bank financial institutions, but in times of crisis, the flow reverses. Therefore, the big banks buffer more liquidity risk than other financial market participants in China. It implies that to explore the economic effects of the explicit deposit insurance system from the perspective of liquidity risk prevention, it is necessary to clarify the mechanism of liquidity risk dispersion, and the key role of systematic important banks in liquidity allocation pattern. Monetary authorities should be aware of the dynamic change rules in liquidity risk management mechanism between micro financial entities, have fully insights into the different risk-taking levels of financial institutions and, take the factors of economic cycle, financial institutions heterogeneity into account fcr regulatory measures, to effectively control the overall liquidity, as well as achieve objectives of liquidity risk precaution.