Political connections, bank deposits, and formal deposit insurance

• Bank political connections matter to attract deposits.
• Political connections matter more to attract bank depositors after the adoption of formal deposit insurance with limited coverage.
• Implementing formal deposit insurance might be beneficial for market discipline but unfortunately it adds value to political connections.

This paper investigates the impact of banks’ political connections on their ability to collect deposits under two different deposit insurance regimes (blanket guarantee and limited guarantee). We use a unique hand-collected dataset that identifies the political connections of Indonesian commercial banks, from Q1:2002 to Q2:2008. We find that, regardless of their type (state-owned or private entities), politically connected banks are able to attract deposits more easily than their non-connected counterparts. We also show that this effect is more pronounced after the implementation of formal deposit insurance with limited coverage. Our findings have various policy implications. Formal deposit insurance might have improved market discipline, as highlighted by earlier studies, but it has also exacerbated the issue of political connections in the banking sector.