The Interacting Roles of Bank Supervisory Effectiveness and Depositor Discipline in a Banking Crisis

This paper examines the interaction between bank supervision and depositor behavior during a banking crisis, utilizing a sample of finance professionals from six developed countries with comparable banking systems but varying supervisory effectiveness. These finance professionals, taking on the role of individual depositors, were asked to indicate their withdrawals from a set of deposit accounts at the onset of a hypothetical banking crisis. The accounts were designed to encompass several likely contributors to depositor decision-making, including deposit insurance coverage and bank capital level. The main results, along with multiple robustness checks performed, indicate that more effective bank supervision is associated with a reduced sensitivity of withdrawals by finance professionals to the risk of deposit loss due to incomplete insurance coverage, particularly when deposits are held at banks with a higher-than-average capital level. This finding brings into focus a potential unintended consequence whereby stringent supervisory practices can diminish the efficacy of depositor discipline among financially knowledgeable individuals, which has implications for the design of banking policy. The results can also help bank managers prioritize strategies to mitigate deposit withdrawals in future crises. Keywords: Bank supervision; Depositor discipline; Banking crisis; Finance professional