Market discipline and deposit insurance reform in Japan

Abstract

On April 1, 2002, the Japanese government lifted a blanket guarantee of all deposits and began limiting the coverage of time deposits. This paper uses this deposit insurance reform as a natural experiment to investigate the relationship between deposit insurance coverage and market discipline. I find that the reform raised the sensitivity of interest rates on deposits, and that of deposit quantity to default risk. In addition, the interest rate differentials between partially insured large time deposits and fully insured ordinary deposits increased for risky banks. These results suggest that the deposit insurance reform enhanced market discipline in Japan. I also find, however, that too-big-to-fail (TBTF) policy became a more important determinant of interest rates and deposit allocation after the reform, thereby partially offsetting the positive effects of the deposit insurance reform on overall market discipline.

Political connections, bank deposits, and formal deposit insurance

“…We use the natural log of deposits (LNDEP) as a proxy of the quantity of bank deposits in line with Imai (2006). To measure the interest rate on deposits, we use the implicit deposit interest rate (INTDEP) measured as the ratio of interest expenses to total deposits following Martinez-Peria and Schmukler (2001) and Hadad et al (2011).…”

“…Large banks are perceived as systemically important banks that would most likely be bailed out by the government if they collapse (Imai, 2006;Onder and Ozyildirim, 2008). Therefore we expect a higher supply of funds for these too-big-to-fail banks, and a lower interest rate paid on deposits (Mondscean and Opiela, 1999;Opiela, 2004;Onder and Ozyildirim, 2008;Hadad et al, 2011).…”

“…Several studies examine depositors' behavior when a blanket guarantee system is replaced with a limited guarantee system. For instance, Imai (2006) finds that the deposit insurance reform in Japan, from a blanket guarantee system to a limited guarantee system, has enhanced market discipline by increasing the sensitivity of deposit interest rates and by increasing the sensitivity of deposit quantity to default risk.…”

Market Discipline in Banking: The Jordanian Experience

“…Imai (2008), Ioannidou and de Dreu (2010), Barajas and Catalan (2011), Murata andHori (2011), Cubillas et al (2012), Karas et al (2012), Thiratanapong (2012), Arnold et al (2015), and Berger and Turk-Ariss (2015) are some of those researchers that used this methodology. For example, based on a total of 2038 banks that operate in the USA, 21 European countries, and in Switzerland, the subperiods 1997-2007 and 2008-2009, and using deposit growth as the dependent variable, it is stated that "we find significant depositor discipline prior to the crisis in both the US and EU… We also find that depositor discipline mostly decreased during the crisis, except for the case of small US banks" (Berger and Turk-Ariss, 2015).…”

The Optimal Level of Deposit Insurance Coverage

“…Demirguc - Kunt and Detragiache (2002), among others, provide evidence that a greater extent of insurance induces more, rather than fewer bank failures. Imai (2006) finds that the switch from a blanket guarantee to limited coverage of time deposits that took place in Japan in 2002 enhanced market discipline. Some other recent studies use experiments to address the impact of partial deposit coverage on bank runs, though the findings are not conclusive.…”