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Flight from Safety: How a Change to the Deposit Insurance Limit Affects Households’ Portfolio Allocation

Author

Listed:
  • H. Evren Damar
  • Reint Gropp
  • Adi Mordel
Abstract
Deposit insurance protects depositors from failing banks, thus making insured deposits risk-free. When a deposit insurance limit is increased, some deposits that previously were uninsured become insured, thereby increasing the share of risk-free assets in households’ portfolios. This increase cannot simply be undone by households, because to invest in uninsured deposits, a household must first invest in insured deposits up to the limit. This basic insight is the starting point of the analysis in this paper. We show that in a standard portfolio allocation model, faced with a deposit insurance limit increase, households move some of their assets out of deposits into risky alternatives, such as mutual funds. Our empirical analysis, taking advantage of a deposit insurance increase in Canada in 2005 and detailed household portfolio data, confirms the insights from the model and stands up to multiple alternative explanations. Hence, we show that an increase in the deposit insurance limit results in a sizable deposit outflow. Our work has important policy lessons. First, although there is considerable evidence on the financial stability consequences of deposit insurance (as it reduces the impact of runs in a crisis), we document a novel implication where enhanced protection may also trigger deposit outflows during non-crisis times. Second, the paper highlights the link between deposit insurance and the composition of household portfolios. It emphasizes the role that uninsured deposits play in the household investment decision and the importance of studying them separately from insured deposits when analyzing portfolio allocation choice.

Suggested Citation

  • H. Evren Damar & Reint Gropp & Adi Mordel, 2019. "Flight from Safety: How a Change to the Deposit Insurance Limit Affects Households’ Portfolio Allocation," Staff Working Papers 19-29, Bank of Canada.
    • Handle: RePEc:bca:bocawp:19-29
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    References listed on IDEAS

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    More about this item

    Keywords

    Financial Institutions; Financial system regulation and policies;

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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