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| Differential Rate Mechanism of Deposit Insurance and Bank Risk-taking: Evidence from China's Rural Banks |
| MING Lei, QIN Xiaoyu, YANG Shenggang
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School of Finance and Statistics, Hunan University;
School of Finance, Shanghai University of Finance and Economics;
Business School, Hunan University |
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Abstract Effectively identifying and preventing risks from problem banks and improving financial security and the emergency response mechanism are increasingly important practical problems. As an important part of the financial safety net, the deposit insurance system can play an early-warning role in dynamic supervision and in the disposal of financial risks.
Regarding the effectiveness of the deposit insurance system, the prevailing view is that a poorly designed system increases the risk of a bank crisis. However, an incentive compatible design can weaken the adverse impact of moral hazards. As an important part of the risk-minimization design of the deposit insurance system, a differential rate can effectively reduce moral hazards in banking.
China established its deposit insurance system in 2015. Domestic scholars discuss the positive and negative effects of deposit insurance on China's banking system, emphasizing how it can prevent risk exposure and the response of regional banks and how to coordinate it with other financial reform measures. Considering these practical problems and research backgrounds, this paper theoretically analyzes the inhibitory effect of the differential rate mechanism on bank risk before and after the implementation of the deposit insurance system. By expanding the model of Freixas and Rochet (2008), it is proved that a differential rate, compared with a fixed rate, can inhibit high-risk investment behavior by banks and alleviate moral hazards. Moreover, a differential rate based on risk makes early correction more effective. This paper selects 119 rural banks which have relatively greater potential risks and uses data from 2015 to 2019 to conduct an empirical test.
The main contributions of this paper are as follows. (1) A theoretical extension of the Freixas and Rochet (2008) model is used to deduce and prove the inhibitory effect of differential rates on bank risk-taking. (2) This paper discusses the impact and heterogeneity of the dynamic transition from a unified rate to a differential rate on bank risk-taking after the establishment of China's deposit insurance system, enriching the theoretical discussion. The differential rate mechanism significantly inhibits risk-taking by rural banks in China, and this inhibitory effect is more obvious for banks with less risk and more assets, whereas the effect on country banks is relatively insignificant. (3) This paper not only verifies the impact of a differential rate mechanism on bank risk-taking but also considers the effect of restructuring rural credit cooperatives on a selected sample of rural banks in a similar period. The results show that in the short term, the reform of rural credit cooperatives intensifies risk-taking of rural commercial banks, but the differential rate mechanism alleviates this negative effect to a certain extent.
According to the theoretical analysis and empirical results in this paper, the following policy implications are obtained: First, improving the design of the deposit insurance system can not only weaken the negative impact of the moral hazards inherent in the system but also increase its role in stabilizing the banking system. We should give full play to thePrompt Corrective Action of the deposit insurance system, which include monitoring and timely intervention, improve the effectiveness of the deposit insurance system in disposing of financial risks, reduce the cost of risk disposal and prevent the infection and diffusion of financial risks. Second, we should strengthen the risk early-warning mechanism and dynamic supervision of small and high-risk banks and require rectification when problems are found, to avoid the accumulation of risks.
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Received: 20 February 2020
Published: 25 April 2022
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