Financial liberalization, deposit insurance and bank stability

Abstract

This article investigates the impact of implementing an explicit deposit insurance scheme on the likelihood of banking crisis in countries with well-liberalized financial systems. We estimate the probability of a systemic banking crisis using a multivariate logit model in which alternative variables capturing the nature of the deposit protection arrangement enter as explanatory variables along with a set of control variables. We conclude that deposit insurance will be successful in alleviating moral hazard and increase the stability of the financial system only if a sufficient degree of financial liberalization exists.

Notes

¹ Financial Stability Forum, Guidance for developing effective deposit insurance systems (September 2001), available at http://www.fsforum.org/publications/publication_19_1.html

² MAS announces programme to liberalize commercial banking and upgrade local Banks, accessed, 17 May 1999, available at http://www.mas.gov.sg/masmcm/bin/pt1MAS_Statement_on_Measures_to_Liberalise_Commercial_Banking_and_Upgrade_Local_Banks__17_May_19991.htm

³ http://www.mas.gov.sg/annual_report/annual20042005/B36_key_enhance1.html

⁴ Gavin and Hausmann (1996) for example, contend that macroeconomic forces could place great strain on the banking system and cause bank failures.