Interbank deposits and market discipline: Evidence from Central and Eastern Europe

There is a considerable debate on the role played by market discipline in the banking industry. Using data for 207 banks across 10 Central and Eastern European countries, this paper empirically analyzes the disciplining role of interbank deposits. We find that market discipline has been effective in Central and Eastern Europe since the implementation of explicit deposit insurance. However, several factors affect the strength of this discipline. State-owned banks are not disciplined probably because they benefit from implicit insurance. Institutional and legal factors, and resolution strategies adopted by countries during banking crises also impact bank risk and the effectiveness of market discipline. Our results indicate that stronger regulatory discipline reduces risk but also weakens market discipline.