The Effect of Deposit Insurance on Risk Taking in Asian Banks

Abstract

This paper uses a panel database of 401 banks in 31 Asian countries over the period from 2000 to 2010 to examine the effects of deposit insurance on banks’ risk-taking incentives. We find that risk-taking incentives vary with bank size and risks. In addition, differentiated premiums may not accurately reflect the level of risk that a bank poses. In the presence of a deposit insurance scheme, the pattern of the non-linear relationship between bank size and risk-taking significantly changes. Our results suggest that market discipline exercised by banks is stronger in the presence of mandatory deposit insurance scheme. Government-funded deposit insurance funds allow Asian banks to take a higher risk. A risk-based deposit insurance scheme functions more effectively in the countries with good regulatory framework and institutional quality.