Regulatory Forbearance and Depositor Market Discipline: Evidence from Savings Banks in Korea

Abstract

This paper investigates whether regulatory forbearance for savings banks in Korea affects the market discipline of depositors using data from 2000 to 2010, which are characterized by a series of exits of savings banks. We find that depositors' sensitivity to the savings banks' asset quality decreases when there is regulatory forbearance for failing savings banks. This forbearance effect is also observed in the behavior of the depositors of the neighboring savings banks in the same business area. These results suggest that regulatory forbearance may cause depositors to misjudge bank risks, increasing the expected costs of bank failure. (JEL G21, G28)