Does a deposit insurance scheme induce moral hazard among bankers? Evidence from an experiment with bankers

Abstract

The implementation of a deposit insurance scheme entails a trade-off. On the one hand, as shown in theoretical and empirical studies, a deposit insurance scheme reduces the likelihood of a bank run. On the other hand, a deposit insurance scheme induces moral hazard among bankers that may lead to bank failures. This study rigorously tests the effect of different deposit coverage limits and the implementation of a differential premium treatment on bankers’ behaviours in the deposit and credit market using a laboratory experiment designed to involve real bankers as participants. This study found that the coverage of limit treatments does not have any effect on the deposit rate offer. Nevertheless, this study found that a high deposit coverage limit induces smaller banks to have a higher share of risky projects. The evidence of moral hazard is particularly found among small banks.