What if the deposit insurance limit was not raised in a crisis? We examine this question using exogenous changes to the deposit insurance threshold and a unique dataset with detailed information on balances and depositor characteristics for every bank account in Denmark. We find that deposit mass in the ranges that remain uninsured decrease by almost 50 per cent in non-systemic banks whereas the decrease is much smaller in systemic banks. While deposits get reallocated within the banking system, systemic banks gain disproportionate amount of large deposits. The reallocation imposes significant funding shocks for banks and affects their lending. We further find that the observed heterogeneity in depositor behaviour is systematically correlated with certain depositor characteristics. The results highlight the significant risks posed to the banking system from differential reallocation of uninsured deposits and hold important policy implications.
Dr Rajkamal Iyer is an Associate Professor of Finance at the MIT Sloan School of Management. His research focuses on the area of banking and contract theory, with a particular interest in understanding the role of interbank markets in the provision of liquidity. Recent research projects include examining the factors that mitigate depositor incentive to run on banks and examining how market participants overcome frictions in contracting.
Iyer holds a BA and MA in Economics from Bombay University, an MSc in Economics and Finance from the London School of Economics, and a PhD in Finance from INSEAD.
Iyer works on issues related to financial crisis, contracting in developing economies, and public policy. Current projects include the role of depositors in monitoring banks, the effect of liquidity injections by central banks on lending, and the dynamics of relational contracting.