Deposit Insurance in Times of Crises: Safe Haven or Regulatory Arbitrage?

Does deposit insurance matter to the international depositor? Does the importance of deposit insurance change during crisis times?

In this paper, Shusen Qi, Harald Sander and I examine the impact of deposit insurance (DI) schemes on bilateral cross-border deposits. Our results suggest that not only the existence of explicit DI, but also DI design features, which reflect its credibility have an impact on cross-border deposits, matter. Furthermore, the relative differences between bank and depositor countries also matter. Thus in stable period, DI serves as a safe haven but also enables depositors to engage in regulatory arbitrage.

In times of crises, depositors rely more on DI in general, but DI acts primarily as a safe haven rather than enabling regulatory arbitrage. During the global financial crisis of 2008/09 the emergency actions of bank country governments, which supply and maintain these safe havens, have led to substantial relocations of cross-border deposits. As such, these actions do not only rescue the banks and domestic depositors of the countries taking these (credible) emergency actions. They also have measurable and sizeable effects on other countries in a financially interdependent world, which may call for coordinated emergency actions which take possible spillovers across countries into account. However, even in tranquil times, our results show that the design of an effective DI must take the DI’s impact on cross-border activities of depositors into account.

Our findings add therefore also to the debate on the design of macroprudential instruments in globalized financial markets. This discussion, currently focused on bank lending, questions their effectiveness when banks and borrowers are able to circumvent these measures via regulatory arbitrage and calls for coordination among national regulators. Likewise, our findings, documenting a novel pattern of save haven and regulatory arbitrage driven behavior by depositors, stresses the need for a coordinated regulatory strategy with respect to deposit insurance schemes.