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Banking Instability and Deposit Insurance: The Role of Moral Hazard

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  • Harold Ngalawa
  • Fulbert Tchana Tchana
  • Nicola Viegi

Abstract

The primary objective of this paper is to investigate the impact of moral hazard on the effectiveness of deposit insurance in achieving banking stability. If moral hazard explains banking instability arising from the adoption of deposit insurance, then deposit insurance will be associated with bank insolvency more than with bank runs. To test the hypothesis, we develop a new empirical framework distinguishing between banking instability initiated by panic withdrawals of deposits, and banking instability initiated by the insolvency problem of banks. Using a dataset covering 118 countries over the period 1980–2004, we find that deposit insurance per se has no significant effect either on bank insolvency or on bank runs. However, interacting deposit insurance with credit to the private sector, we observe a positive and significant effect on bank insolvency and bank runs, suggesting that moral hazard outweighs the positive effect of deposit insurance on banking stability.

Suggested Citation

  • Harold Ngalawa & Fulbert Tchana Tchana & Nicola Viegi, 2016. "Banking Instability and Deposit Insurance: The Role of Moral Hazard," Journal of Applied Economics, Taylor & Francis Journals, vol. 19(2), pages 323-350, November.
    • Handle: RePEc:taf:recsxx:v:19:y:2016:i:2:p:323-350
    DOI: 10.1016/S1514-0326(16)30013-7
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    3. Quintero-V, Juan C., 2023. "Deposit insurance and market discipline," Journal of Financial Stability, Elsevier, vol. 64(C).
    4. Raheel Mumtaz & Imran Abbas Jadoon, 2018. "Effect of explicit deposit insurance premium on the moral hazard of banks’ risk-taking: Around the globe," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 5(02), pages 1-24, June.
    5. Qiao, Lu & Fei, Junjun, 2022. "Government subsidies, enterprise operating efficiency, and “stiff but deathless” zombie firms," Economic Modelling, Elsevier, vol. 107(C).
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    7. International Association of Deposit Insurers, 2021. "Deposit Insurance Coverage Level and Scope," IADI Research Papers 21-12, International Association of Deposit Insurers.
    8. Hasman, Augusto & Samartín, Margarita, 2024. "Competition, coinsurance and moral hazard in banking," Journal of Banking & Finance, Elsevier, vol. 164(C).
    9. Ozili, Peterson K, 2018. "Banking Stability Determinants in Africa," MPRA Paper 101825, University Library of Munich, Germany.
    10. International Association of Deposit Insurers, 2020. "Evaluation of Differential Premium Systems for Deposit Insurance," IADI Research Papers 20-06, International Association of Deposit Insurers.
    11. Amenawo Ikpa Offiong & Peter Kekung Bessong & Arikpo Oka Felix & Godwin Bassey James & Anthony Ogar, 2020. "Deposit Insurance Scheme Activities on Deposit Mobilization of International Association of Deposit Insurer Member Countries: Post Coreprinciple Effect," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 11(6), pages 73-86, December.
    12. Karel Janda & Oleg Kravtsov, 2018. "Micro-level Evidences of Moral Hazard in the European Financial Institutions," Springer Proceedings in Business and Economics, in: David Procházka (ed.), The Impact of Globalization on International Finance and Accounting, pages 89-98, Springer.
    13. Kaelo Mpho Ntwaepelo, 2023. "Bank Stability versus Financial Development: A Generous Deposit Insurer's Dilemma," Economics Discussion Papers em-dp2023-09, Department of Economics, University of Reading.

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    More about this item

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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