Bank Capital, Liquidity Creation and Deposit Insurance

This paper examines how the introduction of deposit insurance influences the relationship between bank capital and liquidity creation. As discussed by Berger and Bouwman (Rev Financ Stud 22:3779-3837, 2009), there are two competing hypotheses on this relationship which can be influenced by the presence of deposit insurance. The introduction of a deposit insurance scheme in an emerging market, Russia, provides a natural experiment to empirically investigate this issue. We use the difference-in-difference approach on a large dataset of all Russian banks. Our findings suggest that the introduction of the deposit insurance scheme has different effects on the relationship between capital and bank liquidity creation across different types of banks. It is those banks characterized by relatively high household deposit ratios that are most affected by the introduction of deposit insurance program. For these banks, deposit insurance reduces the impact of capital on liquidity creation. These findings have important policy implications as they suggest that deposit insurance and capital requirements should not be considered separately by bank regulators.