Market Discipline by Depositors: Evidence from Reduced Form Equations

Abstract

This paper examines the effects of the estimated probability of bank failure on the growth rates oflarge time deposits and interest rates on those deposits. While riskier banks paid higher interest rates, they attracted less large time deposits in the second half of the 1980s. These results indicate that risky banks faced unfavorable supply schedules of large time deposits and, hence, support the presence of market discipline by large time depositors. The empirical analysis also considers the effects of bank size, but fails to find evidence that depositors preferred large banks.

Market discipline in the Central American banking system

“…This third mechanism will not be verified due to lack of information. curves (Park, 1995;Tovar-García, 2014). Where the dependent variables are the interest rate and the growth rate of the deposits, and the main independent variable is the bank risk.…”

“…Furthermore, in developing countries, it is commonly argued that the market discipline tests through prices may be biased by the imperfect information that characterizes these markets and because it depends on the aversion to risk of the depositors (Mayorga Martínez & Muñoz Salas, 2002;Park & Peristiani, 1998;Park, 1995;Tovar-García, 2014). Consistently, there is strong evidence in Uruguay in favor of the market discipline hypothesis through the mechanism based on quantity, whereas there is weak evidence in favor of the price mechanism (Goday, Gruss, & Ponce, 2005).…”

Market Discipline and Deposit Guarantee: Evidence from Australian Banks

“…Given market discipline should affect both the quantity and price of uninsured deposits, Park and Peristiani () examined not only the relation between the amount of uninsured deposits and bank risk, but also that between the interest rates paid on deposits and bank risk. Thus, market discipline should result in smaller quantities and higher interest rates of uninsured deposits at riskier banks (Park ; Martinez‐Peria and Schmukler ). More recently, Maechler and McDill () recognize that the quantity and price response of uninsured deposits in the face of deteriorating fundamentals need to be modeled as an endogenous process.…”

Market Discipline at German Savings Banks

“…Most of the studies support the hypothesis that market discipline is at work and banks are punished for excessive risk taking. Seminal contributions include Baer and Brewer (1986), Ellis and Flannery (1992), Park (1995), Park and Peristiani (1998), Martinez Peria and Schmukler (2001), Maechler and McDill (2006) or Ioannidou and de Dreu (2006). The studies can be further divided into those that control for yields and those that control for the level of deposits in relation to banks' risk taking.…”

“…The problem is that these data cannot easily be observed and therefore reduced-form equations are typically used. For an intuitive discussion of this topic see e. g. Park (1995) and Ioannidou and de Dreu (2006).…”