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AN EMPIRICAL EXAMINATION OF DEPOSIT INSURANCE DECISIONS (MASSACHUSETTS)
Abstract
Federal deposit insurance is optional for mutual savings banks in Massachusetts. This study empirically examines deposit insurance decisions by the banks. These decisions reflect the Federal Deposit Insurance Corporation's (FDIC) regulatory ability and financial credibility. Therefore, the findings of this research may help us evaluate the FDIC's monitoring capability and financial credibility. Three theories are suggested to explain the insurance decisions. First, substitution theory asserts that banks buy deposit insurance as a substitute for bank capital and the FDIC is unable to prevent this practice. This theory predicts that risky banks and nonborrowing banks--not borrowing from uninsured creditors--tend to insure, because the former need more external protection and the latter do not care about uninsured creditors' reaction to the insurance--raising lending rates to insured banks. Second, signaling theory asserts that banks use the insurance as a signal of quality to uninsured creditors and the FDIC is able to maintain the quality of insured banks. This theory predicts safe banks and borrowing banks are likely to insure; because, by sending the signal, safe banks can borrow at lower rates. Third, servicing theory contends that the savings banks treat the insurance as a selling gambit to compete for deposits, because federal deposit insurance is more trustworthy to small depositors than the state deposit insurance. This type of nonprice competition will intensify when a market becomes concentrated. Therefore, banks in a concenrated market are more inclined to insure. Using 1979-1981 data from mutual savings banks in Massachusetts, we test the three hypotheses with a probit model. The signaling and servicing hypotheses are supported by the evidence. The FDIC's supervisory ability and financial credibility are confirmed, because only if it is capable and credible can banks use the insurance as a signal of quality and an additional service. An important implication is that risk-related premia may not be necessary, since banks pay implicit premia for the insurance by meeting regulatory requirements.
Subject Area
Banking
Recommended Citation
DGA, EI-RUN, "AN EMPIRICAL EXAMINATION OF DEPOSIT INSURANCE DECISIONS (MASSACHUSETTS)" (1984). ETD collection for University of Nebraska-Lincoln. AAI8427903.
https://digitalcommons.unl.edu/dissertations/AAI8427903