The Role of Corrective Dynamic Market Discipline in the Relationship between Deposit Insurance System and Bank Moral Hazard: Case of Dual Banking System in Indonesia

Abstract

This study purposes to develop a new concept of market discipline and to examine the role of its concept namely corrective dynamic market discipline in the relationship between deposit insurance system and bank moral hazard.  The data of this study is obtained from semi annually financial statements of conventional banks and Islamic banks in Indonesia over the period from 2005 to 2011 that published by Bank Indonesia. Using path analysis to examine the existence of mediating factor, this study shows the important results. First, paid premium ratio and maximum coverage as the measurement of deposit insurance system negatively affect on solvency ratio and that indicate the existence of moral hazard. Second, paid premium ratio also negatively affects on corrective dynamic market discipline and shows the respond of market into banks decision in determining bank cost. Third, corrective dynamic market discipline positively affects on bank solvency and the result shows the role of market in mitigating bank moral hazard. Fourth, corrective dynamic market discipline doesn’t mediate the relationship between deposit insurance system and bank moral hazard

Keywords: Deposit Insurance, Market Discipline, Moral Hazard