Deposit Insurance and Market Assessment of Banking System Stability : Evidence from Denmark

Considerable debate within academia and the banking community continues to focus on the role of fixed rate deposit insurance. In particular, some argue that mispriced deposit insurance creates further incentives for bank stockholders to take on additional risk. While previous studies of the relationship between deposit insurance and bank market values have been limited to often-modest changes in bank regulations, the 1987 initiation of deposit insurance in Denmark permits the examination of a major change in banking policy. We find that large Danish banks exhibited a modest positive reaction to the announcement of insurance, but that small and risky banks responded negatively. These results contrast with U.S. findings that fixed rate deposit insurance favors riskier banks. We attribute this difference to Denmark's use of market value accounting and a firm closure policy. Therefore, any discussion of changing the deposit insurance structure must consider the system's other regulatory characteristics