Market discipline and deposit insurance: evidence from some Middle Eastern banks

Abstract

Financial intermediaries (banks) and market (stock markets) can play an important role in economic growth. They facilitate a more efficient mobilization of savings, spread risk, and provide liquidity. Given the high costs of banking crises, regulators have always sought the means that promote greater levels of prudence in the behaviour of banks. Indeed Pillar 3 of the Basel Accord relies on enhancing bank disclosure to strengthen market discipline. In other words, Basel II introduces mechanisms to ensure effective governance in financial institutions. The primary objectives of this research are to provide answers to two questions. First, do depositors discipline Jordanian, Kuwaiti, Omani, and Saudi banks? Second, the fact that the Kuwaiti and Saudi deposits are 100 percent insured explicitly and implicitly respectively, while the Jordanian and Omani deposits are insured up to $14,000 and $50,000 respectively, does this difference in the deposit insurance design have any bearing on market discipline. Based on a sample of listed Jordanian, Kuwaiti, Omani, and Saudi banks during the time period 1997 – 2006, the overall results clearly indicate the absence of market discipline in Kuwait, Oman, and Saudi Arabia. In other words, market discipline is at work only in Jordan.