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Do Depositors Discipline Banks and Did Government Actions During the Recent Crisis Reduce this Discipline? An International Perspective

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Abstract

The recent financial crisis highlights the importance of both regulatory and market discipline. Government reactions to the crisis included expanding deposit insurance coverage and rescuing troubled institutions, including some institutions that might not otherwise be considered too important to fail. These actions may have the unintended consequence of a reduction in market discipline that might otherwise penalize banks for risk-taking behavior. Alternatively, market discipline may have increased during the crisis due to heightened awareness of the risks of bank failures. To address these issues, we first test for the presence of depositor discipline effects in the period leading up to the financial crisis in both the US and the EU. Second, we test whether depositor discipline decreased or increased during the crisis. We find significant depositor discipline prior to the crisis in both the US and EU, but this varies between the US and the EU as well as with banking organization size and with listed versus unlisted status. We also find that depositor discipline mostly decreased during the crisis, except for the case of small US banks.

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Notes

  1. In the US, the deposit insurance cap on the dollar amount of funds insured was temporarily raised from $100,000 to $250,000, and this was made permanent by Dodd-Frank. In the EU, moves were made to eliminate co-insurance and raise the deposit insurance coverage caps. See Carbo-Valverde, Kane, and Rodriguez-Fernandez (2008) for more general discussion of deposit insurance and the government safety net in the EU prior to the recent crisis.

  2. Under the 2009 US bank stress tests, the Supervisory Capital Assessment Program (SCAP), the government may have effectively announced that the 19 largest banking organizations were too important to fail by stating that these institutions would need sufficient capital to survive another downturn or would be provided with such capital.

  3. Reasons for these separate treatments are given in the text below.

  4. We also assume that the supply function of deposits does not significantly vary with other factors such as monetary policy changes.

  5. Some studies have also examined interbank market discipline. Furfine (2001) investigates the disciplining effects of the overnight federal funds market and finds that interest rates are dependent on the credit risk of the borrowers. King (2008) uses 20 years of panel data to provide evidence on interbank money market discipline, whereby banks with high credit risk have consistently paid higher rates on interbank loans compared to low risk banks. Similar discipline may be affected by counterparties to off-balance sheet activities. One study finds evidence of market discipline in the standby letter of credit market (Koppenhaver and Stover 1994).

  6. Similarly, Cole and Gunther (1998) find that off-site monitoring is more accurate in predicting bank survivability than two-quarter old supervisory CAMEL ratings. Berger, Davies, and Flannery (2000) also report that, except for recent bank examinations and inspections, bond and equity markets are more accurate in predicting bank performance than supervisory assessments.

  7. Bank opaqueness in the context of the US is also noted by Morgan (2002), who examines the pattern of disagreement between rating agencies when rating banks.

  8. EU countries with unlimited deposit insurance include Ireland as of September 2008 and Slovenia as of November 2008 until December 2010.

  9. In a contemporaneous working paper that is closest to ours, Lambert, Noth, and Schüwer (2013) find an increase in risk taking by some banks in the U.S. after the deposit insurance cap was raised from $100,000 to $250,000 in 2008. However, they do not look at depositor discipline directly.

  10. During the sample period, EU publicly traded firms were required to switch from their national accounting procedures to IFRS no later than January 1, 2005. We account for the change in accounting practices by including time dummies in our analysis, and we do not believe that the adoption of IFRS standards affects our dependent variables.

  11. We winsorize the data at the top and bottom 1st percentile of the distribution.

  12. Quantities of deposits may be subject to window dressing, but we do not believe that it is very often the case. The evidence suggests that banks window dress their assets, rather than deposits (see Allen and Saunders 1992).

  13. Some of these differences may be attributable to changes in exchange rates, but we do not believe this to be a significant factor because most depositors just deal with their home currency.

  14. Our analysis rests on accounting ratios because market values are unavailable for most banks. Any measurement error introduces a bias against finding statistically significant depositor discipline, which we do find.

  15. Kalemli-Ozcan, Sorensen, and Yesiltas (2012) argue that excessive risk taking is not easily detectable at banks because it involves the quality rather than the quantity of assets.

  16. We also tried changes in risk and allowed them to have asymmetric effects and found the main results to hold, but more weakly, with no consistent greater effect of either increases or decreases in risk (not shown).

  17. Deposit growth rate is calculated as 100 multiplied by the natural logarithm of the ratio of total deposits to total deposits lagged by 1 year.

  18. We acknowledge that there could be some inertia in the deposit quantities because some banks significantly rely on term funding, which would bias the results against finding depositor discipline.

  19. Deposit rate premium is calculated as 100 multiplied by the difference between deposit rate and the short-term Treasury rate for the country in question measured at year end, where deposit rate equals the ratio of interest expenses to total deposits.

  20. Asset growth is included to control for any increase in deposits caused by the bank wanting to keep pace with asset growth.

  21. We do not have information on whether banks are government owned, but this should not be a significant issue for most of these developed nations and is not the focus of our study.

  22. We also try fixed effects and our main findings are maintained, but doing so results in dropping some of our important control variables (Foreign, BHC, Deposit Insurance, and UK and US dummy variables), so we prefer the random effects model as our main approach.

  23. We acknowledge the possibility that bank supervisors may affect deposit growth rates in response to bank riskiness. To the extent that this occurs, our findings reflect supervisory discipline as well as depositor discipline. However, evidence from Germany suggests that supervisors only seldomly intervene on the liability side of banks’ balance sheets (Berger, Bouwman, Kick, and Schaeck (2014)).

  24. We acknowledge the possibility that some of the stronger results for the US may be due to more supervisory focus on the leverage ratio compared to the EU.

  25. We conduct tests of differences in the coefficients on bank risk for large US and EU banks and for large listed and unlisted banks. We find that differences are generally statistically significant across most specifications.

  26. We conduct tests of differences in the coefficients on bank risk and similarly find that there are statistical differences in depositor discipline across large and small US banks.

  27. These statistics and results are all available upon request from the authors.

  28. Berger, DeYoung, Flannery, Lee, and Oztekin (2008) use Generalized Method of Moments estimation (Blundell and Bond, 1998) that allows a target variable (the deposit growth rate in our case) to adjust to a long-run desired level slowly over time within a partial adjustment framework.

  29. Not all countries are represented in these lists because some nations had too few observations to measure depositor discipline separately.

  30. For the period 1997:Q1-2006:Q1, we calculate the uninsured deposits as the amount of bank deposit accounts (demand, savings, and time) with a balance on the report date of more than $100,000 minus the number of such deposit accounts multiplied by $100,000. For the period 2006:Q2-2009:Q2, we take into account the different treatment of deposit retirement accounts versus the rest. Thus, we calculate the uninsured deposits as the amount of bank deposit accounts (demand, savings, and time, excluding retirement accounts) with a balance on the report date of more than $100,000 minus the number of such deposit accounts multiplied by $100,000 plus the amount of bank deposit retirement accounts with a balance on the report date of more than $250,000 minus the number of such deposit accounts multiplied by $250,000. For the period 2009:Q3 onwards, we account for the deposit insurance limit increase from $100,000 to $250,000 for all deposits except foreign ones. Thus, we calculate the uninsured deposits as the amount of bank deposit accounts (demand, savings, and time, including retirement accounts) with a balance on the report date of more than $250,000 minus the number of such deposit accounts multiplied by $250,000. While the last change in deposit insurance took place in October 2008, the call report did not change to reflect it until 2009:Q3. For all time periods, we also add the foreign deposits to the uninsured deposits because foreign deposits are not covered by the FDIC deposit insurance.

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Acknowledgments

The authors thank an anonymous referee, Rob Bliss, Arnoud Boot, Bob Collender, Bob DeYoung, Astrid Dick, Stefano Giglio, John Goodell, Ed Kane, Mark Flannery, Phil Molyneux, Herman Saheruddin, Klaus Schaeck, Greg Udell, Larry Wall, Maxim Zagonov, participants at the Federal Reserve Bank of Chicago conference on Bank Structure and Competition, seminar participants at the Money and Capital Markets department of the International Monetary Fund, and participants at the Financial Management Association meeting for helpful comments and suggestions, and Raluca Roman for outstanding research assistance.

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Authors and Affiliations

  1. University of South Carolina, Wharton Financial Institutions Center, European Banking Center, Columbia, SC, USA

    Allen N. Berger

  2. Lebanese American University, Beirut, Lebanon

    Rima Turk-Ariss

  3. Moore School of Business, University of South Carolina, 1014 Greene, Columbia, SC, 29208, USA

    Allen N. Berger

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  1. Allen N. Berger
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Correspondence to Allen N. Berger.

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Berger, A.N., Turk-Ariss, R. Do Depositors Discipline Banks and Did Government Actions During the Recent Crisis Reduce this Discipline? An International Perspective. J Financ Serv Res 48, 103–126 (2015). https://doi.org/10.1007/s10693-014-0205-7

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