Year of Publication

2016

College

Martin School of Public Policy and Administration

Committee Chair

Dr. J. S. Butler

Executive Summary

Countries introduce a deposit insurance system to prevent bank-run and stabilize the financial market by protecting depositors. However, deposit insurance with a flat-rate system induces the insured banks to take more risky activities, an example of moral hazard. To deal with this problem, the Korea Deposit Insurance Corporation ('KDIC') adopted a Risk-Based Insurance Program ('RBIP ') for the Savings Banks ('SBs') on July 1, 2013, by charging a higher rate for the weak SB s and a lower rate for the healthy SBs. To mitigate the initial drastic impact on the SBs in an economic regression, the KDIC had reduced the difference between the regular rate and the higher rate by 90% and the difference between the regular rate and the lower rate by 50%, which is called a soft landing period.

In this paper, I tested the hypothesis that the RBIP in the soft landing period is not sufficient to motivate the SBs to reduce their risk. Also, I tested another hypothesis that the healthy SBs respond better to reduce the risk level rather than the weak SB, because the lower rate as the motivation is more attractive than the higher rate.

I constructed a balanced panel data for the SBs in Korea, and I employed a fixed effect model with instrumental variables to deal with an unobservable individual effect and an endogenous variable. The RBIP rate in the soft landing period was not sufficient, and the reason is that the weak SBs are predicted to increase the risk contrary to the purposed direction of the RBIP.

Based on my finding, it can be concluded that the KDIC should expand the current differential rate for the weak SBs at least, if it wants to achieve the goal of restricting the risk of the SBs.

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