Deposit insurance and financial intermediation : the case of Indonesia Deposit Insurance Corporation

The article analyzes the impact of the establishment of the Indonesia Deposit Insurance Corporation (IDIC) on financial intermediation in Indonesia. The research uses technical analysis and multiple regression data analysis techniques. Results indicated that in the immediacy of IDIC establishment risk aversion increased among savers and banks alike, as reflected by a shift in the composition of bank deposits from time deposits and demand deposits to savings deposits and rising levels of Bank Indonesia certificates held by banks, respectively. However, increase in bank soundness, coupled with confidence in IDIC effectiveness, while mitigates risk-aversion behavior, it seems to have created opportunity for moral hazard in the banking system. Savers’ behavior is no longer driven by consideration of whether or not the potential custodians of their deposits are sound or other, but expected return (interest rate on deposits offered). The same applies to banks, which no longer consider risk-free Bank Indonesia certificates as a good investment. Risk-taking behavior by savers and banks alike seems to be strengthened by expectations of future government intervention for systemically important banks, raising fears of too systemically important to fail problem and continued political intervention in IDIC policymaking. Overall, IDIC establishment by bolstering public confidence in the banking system has reduced the possibility of a repeat of highly destabilizing runs on banks, hence has contributed to better financial intermediation and financial stability. However, rising moral hazard means that future bailouts are still unavoidable.