Excessive Deposit Insurance Prompts Banks to Take More Risks
While helping build consumer trust in credit institutions, deposit
insurance can prompt bankers to engage in risky and opportunistic behaviour;
larger banks tend to be more cautious and do a better job managing troubled
assets, according to Natalia Gorelaya, Associate Professor at the HSE Faculty
of Economic Sciences’ Department of Finance.
Since 2004, Russa has had a Deposit Insurance System
(DIS) covering more than 80% of the country's credit institutions. In the
decade since it was established, compensation amounts have changed four times
and increased 14-fold in total, from 100,000 to 1,400,000 rubles. According to
experts, the availability of guarantees for depositors has greatly contributed
to public confidence in the banking system – even the fairly frequent recent withdrawals
of bank licenses have not caused any bank runs in Russia.
However, the country’s deposit insurance system can
have a dual effect on the economy. While enhancing the financial sector's stability
and public trust in banks, it can cause bankers to become complacent and
over-confident, engaging in high-risk lending and investment and thus
increasing their bank's total risks.
Associate Professor Gorelaya of
the HSE Faculty of Economic Sciences’ Department of Finance conducted an
empirical study to find out how the deposit insurance system affects market
discipline and risk appetites for banks.
She performed her calculations on a large sample of
Russian credit institutions' data collected since the introduction of deposit
insurance (4,588 quarterly observations on 148 Russian banks participating in
DIS between the first quarter of 2007 and the third quarter of 2014). Of the
total sample, two subgroups were selected: large, mostly state-owned, banks and
small credit institutions, and then the correlations between credit risk,
liquidity risk, default risk and the characteristics of deposit insurance
provisions were analyzed for each subgroup. Gorelaya presented her findings in
the paper 'The Deposit insurance System and Its
Effect on Risk-taking by Russian Banks'.
The Cost of Competition
According to Gorelaya, deposit insurance, in and of
itself, does not increase banking risks. However, she found a relationship
between the amount of insurance coverage and the level of risk exposure. This
relationship is not linear, but quadratic: at first, Russian banks' risk
appetites were decreasing with the increase in deposit insurance amounts, but
when, in 2006, the insurance coverage reached a certain point (261,000 rubles,
which is almost 5.5 times less than the 1,400,000 rubles established in
December 2014), banks' risk-taking began to grow once again.
Gorelaya notes that "alongside positive effects,
such as larger balances in deposit acounts, increased amounts of insurance
coverage can also lead banks to take more risks." Knowing that most
depositors expect to recover their funds no matter what and thus tend to ignore
their bank's risktaking, certain credit institutions have engaged in risky
policies trying to beat competition by offering better deals to their customers.
While deposit insurance coverage in Russia is fairly
moderate by world standards – compared, e.g. to the U.S. where it is ten times
higher at USD 250,000 – still, relative to the average size of bank deposits in
Russia (29,000 rubles in 2014), its amount can even be described as excessive.
Large Banks Better at Calculating Risks
Gorelaya has also found that major Russian banks
participating in DIS tend to be more cautious than smaller lenders: compared to
small and medium-sized banks, they usually have a lower proportion of NPLs
(non-performing loans) in their portfolios and thus can allocate a smaller part
of their revenues to loan loss reserves.
In addition, large banks tend to do a better job
managing troubled assets by reducing their size to acceptable levels, even when
faced with large amounts of bad debt.
to Gorelaya, a bank's capital to total assets ratio does not have an effect on
its credit risk (defined as the NPL to total assets) and liquidity risk (expressed
as liquid assets to liabilities ratio).
November 02, 2015