Does a Deposit Insurance Scheme Induce Moral Hazard among Bankers? Evidence from an experiment with bankers

Gumilang Aryo Sahadewo (Department of Economics, Faculty of Economics and Business, Universitas Gadjah Mada)
Bernardinus Maria Purwanto (Department of Management, Faculty of Economics and Business, Universitas Gadjah Mada)
Rimawan Pradiptyo (Department of Economics, Faculty of Economics and Business, Universitas Gadjah Mada)

Gadjah Mada International Journal of Business
Vol 20, No 3 (2018): September-December

The implementation of a deposit insurance scheme entails a trade off. On 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. We rigorously test the effect of different deposit coverage limit and the implementation of a differential premium treatment on bankers’ behaviors in the deposit and credit market. We do so by designing a laboratory experiment that involves real bankers as participants. We find that the coverage limit treatments do not have any effect on deposit rate offer. Nevertheless, we find that a high deposit coverage limit induces smaller banks to have a higher share of risky projects. This is evidence of moral hazard particularly among small banks.