DP1939 | Financial Opening, Deposit Insurance and Risk in a Model of Banking Competition

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This paper studies the impact of competition on the determination of interest rates, and on banks? risk taking behaviour, under different assumptions about deposit insurance and the dissemination of financial information. We find that lower entry costs foster competition in deposit rates and reduce banks? incentives to limit risk exposure. While higher insurance coverage amplifies this effect, two alternative arrangements (risk based contributions to the deposit insurance fund, and public disclosure of financial information) contribute to reduce it. Moreover, uninsured but fully informed depositors and risk based full deposit insurance yield the same, entry cost independent, equilibrium risk level. The welfare implications of the different arrangements are also explored.