Market discipline at German savings banks

Several theoretical studies suggest that only uninsured depositors have an incentive to discipline their banks, i. e. react with changes in deposit volumes or in required interest rates as a reaction to changes in banks’ risk. This paper empirically investigates whether German savings banks are disciplined by their depositors although these should be regarded as fully insured due to public guarantees. Using accounting data for the years 1998 through 2005 we analyze whether the withdrawal behavior and the required risk premia change as predicted by the theory. We find that insured depositors, too, discipline banks by demanding higher interest rates and, to a moderate extent, by withdrawing their deposits. Thus, depositors apparently exert market discipline even when they are fully insured against losses.