RIEB, Kobe University

How Did the Introduction of Deposit Insurance Affect Chinese Banks? An Investigation of Its Wealth Effect

Existing papers analyzing the link between deposit insurance and bank market values have usually been confined to investigating incremental regulatory shifts in the banking sector. The latest case on the introduction of deposit insurance occurred in China, and therefore it gives us a chance to explore the stock market reaction to the major regulatory policy change in banking. Although the introduction of deposit insurance is usually expected to be favorable news for banks, our results show that the average abnormal returns of all listed banks in China are statistically significantly negative on the announcement day. They indicate that investors believe the introduction of deposit insurance has an adverse effect on the banking industry in China. We also find that among bank characteristics such as asset size, z-score, and ROE, only size has a statistically significant positive impact on the abnormal returns of the Chinese listed banks on the announcement day. These results mean that although compulsory deposit insurance certainly enhances small banks' credibility, China's capital markets think that the adverse influence is lower for big banks than for small banks. Our results, which are not fully consistent with those previously found in the United States and Denmark, indicates that the difference in the financial regulatory environment prior to the introduction of deposit insurance leads to differential wealth transfer.