A Research On The Impact Of Deposit Insurance On Banking Stability Under Interest Rate Liberalization

In response to the stagflation, oil crisis and the imbalance of financial resource allocation after the financial crisis in developed countries in 1970s, many countries have begun the financial liberalization reform, in which the interest rate liberation plays an important part. However, while the process of financial liberalization promotes the financial development and economic growth, it is often accompanied by financial instability. Therefore, financial liberation and deregulation are considered to be the indicator and fundamental cause of a banking crisis. In order to deal with the vulnerability of the financial system and prevent a systemic banking crisis, an increasing number of countries along with the IMF, EU and other international organizations have proposed to establish an explicit deposit insurance system. According to the data from World Bank,114 countries and regions that have established an explicit deposit insurance system until 2015. Nevertheless, controversy arises when it comes to the effectiveness of deposit insurance system to maintain the financial stability and to prevent the systemic banking crisis. What are the influences of deposit insurance system on the stability of banking system? Will it lead to a stabilizing effect under the background of interest rate liberalization? Which measurement should banking industry take to deal with the impacts brought by deposit insurance system? These questions have been the focused concern of scholars. In this thesis, we conduct the research based on the cross-country data and will have guiding significance for the banking stability in the process of interest rate liberalization of China.On the basis of above research background and significance, this paper apply both theoretical analysis and empirical analysis and deeply analyzes the effects of deposit insurance scheme on banking stability under the background of interest rate liberalization. Meanwhile, we consider the influences of control variables from three levels:the bank, the industry and the macro economy. First, we state the relevant theories and mechanisms how deposit insurance system and interest rate liberalization affect the banking stability, which lay a foundation for the later empirical study. Second, our empirical analysis can be divided into two parts. The first part based on the forward definition of banking stability builds a fixed effect model using the panel data of 90 countries from 1999 to 2013 and analyzes the effects of deposit insurance system under the background of interest rate liberalization. In addition, we divide the countries into different groups and compare the effects on different type of countries. Finally, we employ the system GMM method to test the robustness of the results. The second part is based on the reverse definition of banking stability. On the basis of the sample characteristics, we use Logit model to study the effects of deposit insurance system on banking crisis under the background of interest rate liberalization.The results show that the increase of interest rate liberalization level will reduce the banking stability either based on the forward or reverse definition. However, the implementation of the deposit insurance scheme will compensate the negative effects of interest rate liberalization and in turn contribute to maintain financial stability after interest rate liberalization. Besides, the stabilization effects of deposit insurance scheme under the background of interest rate liberalization differ among countries of different income levels. The influences are not significant in high-income countries, while are important in medium-income or low-income countries including China. Thus, China need to be aware of the financial risks during interest rate liberalization, strengthen the deposit insurance system and further improve the financial safety net.