What do depositors know about risk?

Abstract

The limited success of bank supervision can be better understood by taking into consideration the country conditions and market-based measures that are effective in constraining bank risk. In the case of Russian Federation and Turkey, regulators' incentive to oversight can be further complicated and hence, it can be argued that depositors compel to select sound banks if they continue to fund intermediation by banks in two countries. In this paper, depositors' sensitivity to risk using change in deposits and the level of interest rates on deposits are tested to understand whether they can effectively limit risk-taking behavior of banks. Comparing depositors' reaction in two countries, we find differentiated reaction by depositors to bank risks. In the Russian Federation, it seems that depositors respond weakly to increased bank risks only with the possibility of withdrawing funds. However, in Turkey depositors exercise both quantity and price discipline on the banks which facilitates in identifying risky banks. Moreover, market development, effectiveness of supervisory agencies, types of banks and types of depositors are found to affect depositors' reaction against banks. The findings of this study suggest that the experiences of depositors in both countries seem to play important role in reliance to market discipline in the future.