Do Depositors Punish Banks for Bad Behavior? Market Discipline, Deposit Insurance, and Banking Crises

TLDR

The study empirically investigates how market discipline interacts with deposit insurance and how banking crises affect market discipline. The authors analyze data from Argentina, Chile, and Mexico in the 1980s and 1990s to assess the interaction between market discipline, deposit insurance, and banking crises. Depositors discipline banks through withdrawals and higher interest rates, deposit insurance does not reduce market discipline, and aggregate shocks during crises affect deposits and rates regardless of fundamentals while increasing investors' responsiveness to bank risk‑taking afterward.

Abstract

This paper empirically investigates two issues largely unexplored by the literature on market discipline. We evaluate the interaction between market discipline and deposit insurance and the impact of banking crises on market discipline. We focus on the experiences of Argentina, Chile, and Mexico during the 1980s and 1990s. We find that depositors discipline banks by withdrawing deposits and by requiring higher interest rates. Deposit insurance does not appear to diminish the extent of market discipline. Aggregate shocks affect deposits and interest rates during crises, regardless of bank fundamentals, and investors' responsiveness to bank risk taking increases in the aftermath of crises.