Does Deposit Insurance Retard the Development of Financial Markets

Using a panel of 87 countries, we find that the introduction of deposit insurance retards the development of nonbank financial markets, the banking sector, and, hence, the overall financial market. This effect is less severe in the short run and can be mitigated by strong law and order, but is generally not positive even with the strongest law and order. Further, design features that benefit depositors influence the negative effect on nonbank markets. Our results suggest that externalities arising from deposit insurance make concerns about its effects more pressing than those arising solely from the evidence for the banking sector.