How Does Deposit Insurance Affect Bank Risk? Evidence from the Recent Crisis

This paper examines whether deposit insurance schemes have a stabilizing effect during financially turbulent periods. A sample of 4,109 publicly traded banks in 96 countries was studied to understand the impact of deposit insurance on bank risk and systemic stability separately for the crisis period from 2007 to 2009, as well as the three years from 2004 to 2006 leading up to the global financial crisis. Key findings include:

• Generous financial safety nets increase bank risk and systemic fragility in the years leading up to the crisis;
• Both standalone bank risk and systemic risk are lower during the global financial crisis in countries with deposit insurance coverage;
• Deposit insurance seem to have offered significant stabilization effects during the banking crisis;
• Good bank supervision can alleviate the adverse consequence of deposit insurance on systemic risk in good times.