Deposit insurance not enough of a safety net against bank runs, study shows
CUSTOMERS tend to withdraw their funds, regardless of size, in the event of bank failures even as these are backed by deposit insurance, according to a journal article by officials from the Bangko Sentral ng Pilipinas (BSP) and the University of the Philippines School of Economics (UPSE).
“Deposit insurance is expected to provide depositors with a safety net to address information asymmetry. Yet we find that even small depositors take early private action prior to closure,” according to the article.
“While deposit insurance provides reinforcing effects, it also does not prevent runs in the presence of local adverse information of possible bank stress.”
The article authored by BSP Governor Eli M. Remolona, Jr., BSP Senior Assistant Governor Johnny Noe E. Ravalo, and UPSE Professor Emeritus Dante B. Canlas, who is also a former National Economic and Development Authority director-general, was published in Elsevier’s Journal of Financial Stability last month.
The study also found that bank closures lead to “significant withdrawals by depositors at other banks in the vicinity.”
“Their withdrawal is suggestive that their fear of a loss in liquidity, even if this is temporary in principle, outweighs the assurance of the insurance. For banks, the gain of ‘sticky deposits’ is not without cost,” it said.
“Paying the insurance premium can be seen as a means for disciplining the banks against the fear of a run. Yet again, there appears to be a market for information that allows both small and large depositors to withdraw early.”
Deposit withdrawals before a bank’s closure “raise the issue of bank liquidity,” it said. Under Basel III standards, the liquidity coverage ratio (LCR) must be at least 100% at all times, after considering run-off rates for stable and less stable deposits.
“Our findings make the case that the run-off rates would be relatively the same for the smallest-sized retail deposits and the larger-sized uninsured deposits. Thus, their LCR treatment would not be any different between these polar extreme deposit balances.”
The data also showed that small depositors behave similarly to large depositors.
“Both small and large deposits are withdrawn up to 4-5 quarters before the bank’s closure,” it said. “This has implications. For small deposits, acting on the information they have gathered is suggestive that their cost of foregone liquidity, in the event of closure, is not offset by the comforts of deposit insurance.”
“Furthermore, it appears that depositors with small balances withdraw at the same time as those with large balances. This is unexpected since we do not envision any coordination between small and large balance depositors.”
It noted that this similarity was “unusual” as the small deposits sampled for the study were covered by deposit insurance, versus the large deposits that were not insured.
“In interpreting all these results together, we suggest that while a large bank failure can lead to contagion, small and large depositors do not behave that differently. Indeed, in our informal look at the events, we find that both small and large depositors tend to anticipate that their bank is about to fail and thus start to withdraw before the bank is closed.”
This dispels the notion that small depositors are less informed than large ones, the article said.
“If in general small depositors were as well informed as large depositors, then they would likely not behave differently. We find that this is indeed the case in our analysis of head office data at the town level, in which depositors, large and small, react similarly to a bank failure nearby,” it said.
“What all this means is that financial inclusion in the form of access to bank deposits is not likely to add to instability to the banking system, but it is not likely to reduce instability either.” — Luisa Maria Jacinta C. Jocson
