Depositor Behavior and Market Discipline in Colombia

The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This study examines how depositors decide among different banks and over time in Colombia, with particular attention to the issue of market discipline. By controlling for a more comprehensive set of risk/return factors, the study strengthens the conventional test for market discipline, and addresses two sets of questions of particular interest: (1) How do banks gain or lose market share? Which specific return or risk factors are the most important in explaining a bank's deposit growth? (2) How well do depositors discriminate between well and poorly managed banks? Panel data estimations for the 1985-99 period show that deposit growth is related to bank fundamentals, even after controlling for other risk-return factors. There is also evidence that depositors’ choices effectively discipline banks; following “fundamental” deposit losses, banks tend to improve their fundamentals. Finally, banks with strong fundamentals appear to benefit from lower interest costs and higher lending rates, thus leading to the conclusion that market discipline exists in Colombia – perhaps complemented by “regulatory discipline” – and that moral hazard stemming from deposit insurance is limited, perhaps a consequence of certain design features of the insurance scheme. JEL Classification Numbers: G21