Deposit Insurance and Bank Risk: Does Dual Banking Supervision Matter?

Abstract

The implementation of explicit deposit insurance rises the moral hazard of bank’s risk-taking triggered by the reduction in depositor's monitoring. In the light of economic theory, we examine that whether to allocate additional supervisory authority to the deposit insurer in the presence of a banking supervisor who is expected to decrease the risk taking of banks. We employ 1,856 banks from eighty-seven countries from 2002-2015. Hierarchical Linear Models (HLM) are employed and it reveals that the provision of supervisory authority to a deposit insurer reduces the risk taking activities of banks. In addition, the deposit insurer's supervision enhances the bank’s soundness in noncrisis effected countries. Moreover, allocating the additional supervisory powers to deposit insurer appears as the additional force which mitigates the bank’s risk-taking in the presence of financial supervisory authority. However, this effect is bigger in non-crisisaffected countries. So, the allotment of supplementary supervisory powers to the deposit insurer enhances the investors and depositors' assurance on the financial stability.