DEPOSIT INSURANCE AND MORAL HZARD PROBLEM: THE CASE OF TURKISH BANKING SYSTEM

Alövsat MÜSLÜMOV (Doğuş University)

This paper analyzes the effects of 100 percent explicit deposit insurance system on the performance of Turkish banking system using financial data of the banks operating in Turkey. The theoretical framework hypothesizes that when domestic banks are subject to moral hazard problem due to the explicit deposit insurance system, their overall performance deteriorate. Moral hazard problem arises in the presence of explicit deposit insurance system, since explicit deposit insurance system reduces the incentives of depositors to monitor banks, and results in the risk-return asymmetry due to the design of explicit deposit insurance system as multiparty principal-agent contracting problem.

I test the impact of explicit insurance system on the performance of Turkish banking sector using experimental design approach. I found that the overall performance of Turkish banking sector worsened after the introduction of explicit deposit insurance system. However, the deterioration in the performance of banks which are more exposed to the moral hazard problem due to their specifications is significantly higher. I found that small-sized, domestic, private, deposit-taking banks which are more exposed to moral hazard problem experience weakening capital adequacy level, deteriorating income-outcome balance, increasing credit and liquidity risk, increasing average interest expenses and agency costs. Since these changes in the banking performance variables are industry-adjusted due to their definition, it is most probable that this deterioration is due to the moral hazard problem introduced by explicit deposit insurance system.