Bank Runs and the Impact of Deposit Insurance

Deposit Insurance
Deposit Insurance

Examining the Reasons for Bank Runs and the Impact of Deposit Insurance on Bank Stability in China

Chapter 1 Introduction

1.1 Background

Bank runs remain one of the major problems affecting banking development due to their impact on bank liquidity, which could lead to bankruptcy. Kaufman (1987) suggests that when a bank faces a credit decline and rumours of bankruptcy, people are afraid that banks cannot repay their deposits on time, such that a significant number of depositors withdraw cash at the same time in what is known as a bank run. This may lead a bank into a liquidity crisis, and eventually insolvency. According to the House of Commons Treasury Committee (2008) in 2007, the US subprime mortgage crisis led to the global financial crisis, and many financial markets around the world faced a decline in liquidity, a sharp reduction in interbank lending market, and a large volatility in money market interest rates. Many international financial institutions during the financial crisis went into bankruptcy, including Northern Rock Bank in the United Kingdom, which has more than 150 years of history (Shin, 2008). On the 14th of September 2007, Northern Rock faced liquidity shortages and rumors of the acquisition, which caused a large number of depositors to withdraw their cash and ultimately led to Northern Rock nationalization to prevent the bank run (Shin, 2008). A run on Northern Rock Bank became the iconic event of the US subprime mortgage crisis affecting the European financial industry.

Although in the current financial environment China’s banking system is relatively stable, because of the large share of government ownership, bank runs have also occurred. In June 1998, due to a run on the Hainan Development Bank, it was unable to repay its debts, the bank declared bankruptcy. Later on 23rd April 2014, there was a run on Jiangsu Sheyang local commercial bank, the local governments had to take urgent action to calm depositors’ panic on April 23, 2014 (Simon, 2014, This incident also spread to the other local commercial banks. To prevent bank runs on March 31, 2015, China officially announced the “deposit insurance regulations.” The program, which officially took effect on May 1st, 2015, applies to all commercial banks, rural credit cooperatives and rural cooperative banks and other deposit taking institutions; except branches of Chinese banks overseas and foreign bank branches (Desai, 2016). The Bank of China is responsible for the implementation of the deposit insurance system (eDaily, 2015). However, China deposit insurance system is still in the preliminary stage and needs further development.

The characteristics of China’s financial institutions are similar to the Northern Rock Bank before the incident. In China, there is a rapid growth of real estate market, and therefore bank mortgage lending is growing very fast (Nanto, 2009). If the bank runs crisis occurs, a liquidity crisis could occur if there is no timely rescue from the Central Bank and the government.

Based on the case of the Northern Rock Bank run and the recent financial crisis resulting in the lack of liquidity, many countries (such as the UK, the US and China) implemented the deposit insurance system to avoid bank runs, which has important practical significance on the development of banking and the financial system stability in China.

This study focuses on analysing the overall deposit level of the banking sector in China and attempts to establish the impact of the deposit insurance system on commercial banks’ stability. The research will analyse the possible caused of a bank run in China, determine changes in risk-taking behaviour among banks and provide recommendations on the effective use of deposit insurance system to prevent bank runs. 

1.2 Statement of the Problem

On March 31, 2015, China officially announced the deposit insurance regulation, 20 years after the Chinese authorities first undertook the discussions (Desai, 2016). This was considered an imperative step towards stabilizing banks by making them more resilient to financial crises and preventing related occurrences such as bank runs and insolvency. The deposit insurance regulation would cover all deposit-taking institutions, from commercial banks to rural cooperative banks (Desai, 2016). It has been slightly over two years since the introduction of the deposit insurance requirement among banks in China, and the need to evaluate the impact of the regulation on banks’ performance is of the essence. Different perspectives have been put forward regarding the possibility of bank runs and how the use of deposit insurance could affect bank performance. Having delayed the adoption of DIS as other major economies adopted it following the 2007-08 economic crisis, China is finally in a position to deal with bank failures (Zhou, 2016). In this regard, the deposit insurance system is expected to have significant implications for China. These implications have not yet been studied since the introduction of deposit insurance regulations. Existing researches have only sought to determine the implications of deposit insurance but have not sought to compare bank performance in China following the regulation of deposit insurance. Therefore, there is need to examine the relationship between the deposit insurance system and the performance of banks in China, including their risk-taking behaviour following the introduction of deposit insurance. This research examines how deposit insurance has impacted the Chinese banking sector, by studying the implications of deposit insurance on the financial performance of banks and the occurrence of bank runs. It also studies the implications of deposit insurance on the risk-taking behaviour of banks in China with an objective of establishing whether deposit insurance has had an impact on China’s banking sector and the economy at large. 

1.3 Research Objectives

  1. To examine the role of deposit insurance in managing bank runs in China
  2. To analyse the impact of deposit insurance on the financial stability of Chinese banks
  3. To compare the difference in risk-taking behaviour among Chinese banks before and after the formal introduction of the deposit insurance system

1.4 Research Questions

  1. Has deposit insurance reduced the number of bank runs in China?
  2. How deposit insurance enhanced the financial stability of Chinese banks?
  3. How has the risk-taking behaviour of banks in China changed following the introduction of deposit insurance system?

1.5 Rationale and Contribution

Deposit insurance became an important aspect of bank management following the financial crisis of 2007/2008. As a result, the deposit insurance system was introduced in order to avoid public panic and bank runs (Anginer, Demirguc-Kunt, & Zhu, 2014). Despite the perceived importance of deposit insurance, it is often argued that it could lead to moral hazard behaviour and contribute to risk-taking, thus fuelling another crisis altogether (Calomiris & Jaremski, 2016). Since its introduction, the issue of deposit insurance has been studied extensively. Mikajkova (2013) studied the role of deposit insurance in financial crisis establishing that it is instrumental in contributing to financial stability in countries. However, Chu (2011) examines banking stability in relation to banking insurance and argues that deposit insurance is not necessarily an optimal policy in eradicating bank runs. He suggests that this could be due to the moral hazard effect associated with deposit insurance and the fact that bank runs could be effective in creating elevated stability in the banking sector over time. Maysami & Sakellariou (2008) analyse deposit insurance and determine that despite the associated moral hazard, deposit insurance is highly effective in enhancing banking stability. Allen, Carletti, and Leonello (2011) and Ioannidou and Penas (2010) also study the impact of deposit insurance on risk-taking behaviours among banks, with an indication that deposit insurance automatically increases the risk-taking behaviour of banks. However, these studies and generally most of the literature largely focus on the developed economies, such as the US, the UK, and Europe. This can be due to the recent financial crisis and the resulting shortage of liquidity that led to a run on Northern Rock Bank. Literature in the developing countries is less common, and thus a significant gap in literature exists. Given that Deposit Insurance Scheme in China was introduced relatively recently, in March 2015, this makes this topic especially current and relevant to investigate. This study, therefore, will provide an important contribution to the literature by examining the deposit insurance scheme and reasons for bank runs in China over the most recent years from 2012 up until the first quarter of 2017. It will also contribute to literature through an assessment of the impact of deposit insurance on banks’ financial performance and risk-taking behaviour. These are important study aspects, and by conducting a research on major banks in China, it will be possible to relate the deposit insurance system with performance and risk-taking bahaviour, and compare the findings of this study with the previous literature on deposit insurance and its impact on the banking system.

1.3 Dissertation Outline

This dissertation is divided into five chapters as follows:


The introductory chapter provides a background to the research, introducing the main objectives of the research and the rationale for the research. It establishes the gap that exists in research and the contribution of this study to the existing knowledge.

Literature Review

This chapter examines the findings of the previous literature to establish the existing knowledge regarding bank runs and the impact of deposit insurance on bank stability and risk-taking behaviour.


The methodology chapter informs the research design and approach used in obtaining data for the research. It provides information on the sources of data and discusses the data analysis method utilized to conduct the research

Results and analysis

This chapter consists of the findings of the research and thus provides the results of the study and answers to the research questions. This is achieved through analysis of the data collected and comparison with the findings from the previous studies. 


The concluding chapter provides a summary of the dissertation, including the final findings from the research.

Chapter 2 Literature Review

2.1 Introduction

This chapter consists of a review of previous literature on the subject of bank runs. It includes research done on how bank runs occur, their implications and solutions that have been put forth to address the issue of bank runs. The chapter also includes a review of the literature on the use of deposit insurance as a means of curbing bank runs. The literature review chapter will not only provide background information about the subject of study, but it will also contribute to data analysis by providing a basis for comparison between the current research and previous researches.

2.2 Liquidity/Maturity Mismatch

Liquidity problems play a considerable role in driving financial crisis and is thus considered a one of the major causes of bank runs (Gertler & Kiyotaki, 2013). This explains why liquidity is an important factor in the banking sector and why liquidity mismatches could be detrimental to a bank’s survival (Gertler and Nobuhiro Kiyotaki, 2012). Liquidity and maturity transformation consists of the major business focus of banks, where longer-term assets (loans) are funded with short-term liabilities (deposits) (Gertler and Nobuhiro Kiyotaki, 2012). Maturity transformation, which is considered a primary cause of liquidity problems among banks, refers to the practice at which banks borrow money on shorter time frames than they give when lending out (Freixas, & Rochet, 2008). Banks may borrow on a short-term basis through short-term deposit certificates and demand deposits and lend on long-term such as through mortgages and other loans. This way, they transform short-term maturity debts into long-term maturity credits, thus gaining profit from the difference in interest rates. While this is profitable for banks, maturity transformation also poses considerable risks, such as the rise of short-term funding costs at a faster rate than the bank can recoup its gains from lending (Freixas, & Rochet, 2008). When there is an imbalance between asset maturity such as loans and liabilities maturity on a bank’s balance sheet, this may lead to liquidity issues, thus contributing to a bank’s financial stability in the event of a financial crisis (Gertler and Nobuhiro Kiyotaki, 2012). Choi and Zhou (2014) discuss liquidity mismatch as a result of liquidity transformation and explain that this was a major cause of the 2008 financial crisis. Liquidity mismatch could lead to reduced liquidity among banks and eventually low liquidity in the market (Brunnermeier & Pedersen, 2008). This explains why liquidity regulation has become an important measure in maintaining bank stability. Under Basel III for example, banks are required to maintain Tier 1 Capital of not less than 6% of risk weighted assets and Common Equity Tier 1 Capital of not less than 4.5% of risk weighted assets at any given time in order to enhance liquidity (Bank for International Settlements, 2010). While there is a consensus that liquidity is a major cause of concern which requires regulation, there seems to be no unanimity on how liquidity should be measured when establishing regulations (Bai, 2014).

Liquidity risk, therefore, becomes a widely studied aspect in the study of bank runs. Farag (2013) defines liquidity risk as the inability of a bank to meet its short-term financial obligations. This is most evident when the bank cannot effectively meet its obligations without having to convert its assets or without sacrificing its income or capital to pay debts. (Farag, 2013) As banks aim at leveraging the maturity mismatch between assets and liabilities, liquidity risk is inevitable when the bank is unable to pay its obligations. Liquidity risk may emerge as a result of excessive lending, such that in the event of default payments, the bank may not effectively manage its finances. When bank runs occur, liquidity risk is imminent because the withdrawal of deposits means that banks do not have adequate time to recover profits from loans in time to pay depositors, thus leading to bankruptcy. 

2.3 Reasons for bank runs

A bank run is one of the traditional problems of commercial banks. Based on the harm of bank runs on deposits, banks and financial stability, scholars from various countries have put forward the measures, such as maintaining a reliable capital base, seeking alternative sources of liquidity, improvement of the information disclosure system, and the establishment of the risk early warning mechanism to prevent the run crisis and deposit insurance systems to prevent and deal with liquidity problems.

Diamond and Dybvig (1983) suggest that a bank run is a spontaneous and random phenomenon, bank runs can happen due to the inherent characteristics of banks, such as high asset-to-liability ratio, liquidity and maturity mismatches and following service principles. Diamond-Dybvig model was built based on the various bank runs affecting the world in the 1980s. Allen and Gale (1998) use the hypothesis of preference and technology in the D-D model to link the uncertainty of the return of bank assets with the industrial cycle. They believe that the industry cycle is the cause of bank panic. Chari and Jagannathan (1988) postulate that the bank run began due to depositors’ fears of bank insolvency. Jacklin and Bhattacharya (1988) suggest that due to the asymmetric information theory the bank cannot observe the real liquidity needs of depositors, and depositors do not know the quality of the bank’s assets, so the withdrawal of depositors depends on the choice of the bank’s return on risk assets.

Schumacher (2000) pointed out that Argentina’s bank run in 1994 was caused by deterioration in the fundamentals of the economy, and many banks in the economic crisis were more prone to bank runs. Ennis (2003) discusses a standard banking model that often appears in a variety of economic literature. Ennis (2003) assumes that the investment returns are stochastic. On this basis, he establishes a bank run model that is similar to the D-D model. Goldstein and Pauzner (2005) believe that asymmetry of information under the macroeconomic deterioration led to bank runs.

Macey (2006) points out those banks are susceptible to a run due to the bank’s inherent characteristics. He believes that banks tend to be unstable because depositors tend to rush to withdraw money under the “first come, first served” rule. If a big number of depositors require a large amount of cash urgently, they might attempt to withdraw their cash all at the same time, which can lead to a bank run.

2.4 Measures to Prevent Bank Runs

A bank run can be a random or unpredictable characteristic, and therefore, it is necessary to establish a prevention mechanism in financial supervision. There are various measures to prevent bank runs, which include: the incorporation of the protection of the deposit insurance system, improvement of the information disclosure system, and the establishment of the risk early warning mechanism to prevent the run crisis.

The establishment of the deposit insurance system is an important part of the financial safety net (Pidm, 2017). Bryant (1980) argues that the deposit insurance system in the entire financial system has an irreplaceable role and that financial stability is pegged on effective deposit insurance mechanisms. Diamond and Dybvig (1983) using the D-D model of bank runs indicates that deposit insurance system provided by the government can prevent bank runs. Deposit insurance system establishes a firewall to protect the economy from the financial crisis by enhancing depositors’ security. This can also allow for an effective supervision of the financial institutions and protect the national economy from the financial crisis. Laeven (2004) indicates that the deposit insurance system not only protects the interests of depositors but also preserves the forces that can cause significant market volatility. However, a study by Anginer, Demirguc-Kunt, Zhu (2014) also finds that while deposit insurance can promote stability in financially turbulent times, it can also lead to the increased risk-taking behaviour of banks in normal times, known as the ‘moral hazard effect’ of deposit insurance. Their sample covers the publicly listed banks in 96 countries and the period that includes the recent financial crisis from 2004 to 2009.

Another measure to prevent a bank run is the establishment of a sound information disclosure system and early warning mechanism. Park (1991) pointed out that the lack of information is the main factor that can lead to a run on the bank. Therefore, to prevent the bank run, information is crucial for depositors to fully understand the condition of the banks, which can reduce the probability of bank runs. Yorulmazer (2003) pointed out that high-interest rate of the central banks may exacerbate banks liquidity problems, and therefore, the central bank should provide interest-free loans to bailout the banks in times of financial difficulties.

2.5 Deposit insurance system

The deposit insurance system was first introduced in the United States in 1933, and the Federal Reserve Insurance Corporation (FDIC) was created by the United States under the Glass-Steagall Act of 1933 to provide deposit insurance for banks and non-bank financial institutions. After nearly 80 years of operation, FDIC effectively catered for deposit insurance maintaining the public confidence in the banking system. Since then, many countries, such as United Kingdom, Germany, Asia and China have established a deposit insurance system. However, while this system can enhance financial stability, it also has aspects to improve. The next sections discuss the advantages and disadvantages of a deposit insurance system.

Deposit insurance has been defined by Demirguc-Kunt, Kane & Laeven (2014)as the measures that are put in place by banks in many countries with the objective of protecting their depositors from any consequential losses that may arise from the bank’s inability to fulfill its financial obligations like paying the debt. This insurance is a component of financial system safety net that aims at promoting and enhancing financial stability (We, 2015).

Financial risks are a major concern for most banks, and therefore, these financial institutions are encouraged to invest most of the money in their deposit accounts as opposed to just safe-keeping the full amounts. Such investment risks include the failure of borrowers to repay, financial crisis, and over-reliance on customer deposits which can be withdrawn quickly in the event of possible insolvency (Mishkin, 2007). It is for these concerns that banks must develop and implement economic and monetary policies to increase the public confidence in the security of their finances. Deposit insurance institutions are principally run by the government in full or in partnership with the private sector. Many of these institutions are members of the International Association of Deposit Insurers (IADI). This is an umbrella organization that was established to ensure financial systems stability through contribution to and promotion of cooperation on the international level on matters relating to deposit insurer and related parties (Muhlnickel& Weib, 2015).

According to Anginer, Demirguc-Kunt & Zhu (2014), one implication that deposit insurance has on bank’s risk taking is the unintended consequence of a reduction in depositor incentive to monitor banks. This consequently leads to excessive risk taking and systemic fragility. This is usually the prevailing situation in the years that subsequently lead to global financial crisis. However, in the case of the global financial crisis, the countries, which had deposit insurance measure in place experienced, lower bank risk and more systemic stability than countries, which did not have such policies, implemented (Nanto, 2009). The overall effect of this insurance system on bank risk is negative, however, since the destabilization effect during the regular times is more magnified as opposed to the stabilization effect of economic turbulence (Anginer, Demirguc-Kunt & Zhu, 2014).

The net effect of deposit insurance on bank risk is dependent on whether its benefits to the bank, depositors and the economy at large, can outweigh its costs and negative impacts (Nanto, 2009). Positive impacts of these policies can be compounded by increased bank supervision by depositors and economic monitors. Proper and effective bank monitoring and evaluation can help to ensure and promote deposit insurance benefits during difficult economic periods and help mitigate its negative effects when normal economic periods are prevailing. By offering protection to the interests of the majority inexperienced depositors and correspondingly helping in the prevention of bank runs, deposit insurance policies can lead to enhanced social welfare and therefore reduced financial and bank risks. According to economic studies carried out, adopting deposit insurance is directly linked to decreased bank risk in the European Union (Gros & Schoenmaker, 2014). The positive impact of the insurance policy however can be overshadowed by the fact that banks can undertake excessive risks because they rely on the financial security it provides.

2.5.1 Pros and Cons of deposit insurance system

The uniqueness of debt management in the banking sector determines the inherent vulnerability of the banking system. In the game model of Diamond and Dybvig (1983), depositors have potential liquidity demands for bank deposits due to different risks. Also, bank runs are only made by an external factor or the result of irrelevant factors. In this respect, the government should be through the final lender mechanism for the timely shortage of liquidity in the bank to provide loans and should be through the establishment of deposit insurance system to prevent the information asymmetry caused by a bank run.

Chari and Jagannathan (1988) argue that bank runs are not entirely random events, but that the depositors are based on the rationality of negative information on bank solvency. When the depositors saw people standing in front of the bank waiting for a long team to withdraw money, they found that the bank had operational difficulties. In response to this phenomenon, strengthening the regulation of non-liquidity demand depositors, strengthening the confidence to continue to hold deposits, can effectively prevent a bank run. In 1992 Argentina abolished the deposit insurance system, but soon after that when Mexican financial crisis broke out in Argentina in 1995 they had to re-introduce the deposit insurance system (Miller, 1996). This example effectively demonstrates the importance of deposit insurance in maintaining economic stability through enhancing the performance of banks.

Cull et al. (2002), through empirical analysis of the data provided by the World Bank in more than a dozen countries, found that deposit insurance reduced the systemic risk of banks, and the explicit deposit insurance was superior to implicit deposit insurance in protecting a country’s financial Stability more effectively. When a financial institution is in crisis, the state can provide emergency relief. As Barth (1990) found, the Federal Deposit Insurance Corporation, with sufficient authority, was able to correct in the early years of a bad situation in a financial institution and could keep its troubled bank before it could endanger its national banking liquidity shut down.

Although the deposit insurance can help to improve the bank’s anti-risk ability, it also has disadvantages. The most important drawback of deposit insurance is that it can lead to moral hazard: the existence of deposit insurance makes bankers more inclined to pursue high-risk, high-yield, but do not have to bear the additional costs, but these costs passed on to the deposit insurance institutions, thus leading to the moral hazard (Zhou, 2016). This is particularly common where implicit insurance is provided by the government, such that the banks take advantage of the fact that any losses would be covered by insurance and not them, thus engaging in risky undertakings without caution (Kauko, 2014). Such moral hazard makes deposit insurance disadvantageous, and it could be potentially harmful to the economy if not well monitored (Kim, Kim & Han, 2014).  

Financial institutions that pursue high-risk investments tend to pay higher interest rates to attract money. In the case of Iceland, which had a financial crisis in 2008, the Icelandic Savings Bank provided a dividend of up to 5.25 per cent for depositors, but the Dutch Cooperative Bank for the same period provided only a 3.4 per cent interest rate (Faure and Hu, 2013). This shows that deposit insurance by banks provides increased investor confidence because they are assured that insurance will cushion the financial risk. Accordingly, this encourages banks to pursue high- risk activities, which has a negative impact on the solvency of banks.

The second drawback of the deposit insurance system is that when its coverage is too broad, it will have a negative impact on the financial environment of a country (Calomiris & Jaremski, 2016). In times of financial crisis, deposit insurance is considered important in restoring depositor confidence, thus safeguarding liquidity and preventing bank runs (Zang, Cai, Dickinson & Kutan, 2015). However, when banks take advantage of this provision to increase their risk-taking behaviour, this could potentially lead to a crisis (OECD, 2017). Keeley (1990), found that deposit insurance, while increasing banking competition, also led to a decline in the concession value which led to an increase in bank defaults. Increasing and the decreasing capital adequacy ratio of deposit insurance arising from risky assets further increased the risk of bank management.

A third disadvantage is the deposit insurance system is the reduced likelihood of depositors being in a position to assess financial institutions at risk. Kaufman (1996) argues that due to the information hindrance deposit insurance places on depositors, banks should be subject to a system of regulated deposit insurance, which is not insured by a deposit above the quota and thus encourages large depositors to exercise effective supervision of financial institutions. This way, depositors can monitor banks and make decisions that ensure that their deposits are safe.

However, White (1996) argues that deposit insurance is not suitable for developing countries and countries with economies in transition because deposit insurance will bring negative incentives to depositors. When banks adopt deposit insurance, this creates an illusion of bank stability and depositors may be perceive a bank as being safer for their deposits as opposed to a bank with no insurance (White, 1996).

Vletter van Dort (2009), a corporate law expert, argues that the deposit insurance system provides financial consumers with a false signal that financial products are mistaken for money when they buy deposits as financial products. It can be seen that the idea of questioning the deposit insurance system has always existed, but it has rarely been put forward, but it is hoped that the defects and problems in the system will be found and perfected to promote the stable development of the banking industry.

2.5.2 Implementation of the Deposit insurance system in different countries

In the practice of global banking regulation, the Basel Committee concluded that the financial safety net includes three major tools: administrative prudential regulation, the central bank lender of last resort, and the deposit insurance system (IADI, 2012). As one of the “three magic sins” of the financial safety net, the deposit insurance system played an important role in maintaining financial stability and protecting the interests of depositors (Schumacher, 2000). The deposit insurance system became more and more popular in the world, with only 20 countries established in 1980 and rapidly increasing to 87 countries by the year 2003 (Demirgüc-Kunt et al., 2008). According to the International Deposit Insurance Association (IADI), 113 countries and territories have established the deposit insurance scheme by the end of January 2014, and 41 countries (including China) were preparing to establish deposit insurance system. China implemented its deposit insurance regulations on March 31, 2015, and on May 1, the program took effect.

Before the deposit insurance system, China used the implicit deposit insurance system, where the Central Bank and the People’s Bank of China would implement the mandate of ‘lender of last resort,’ thus paying out consumer funds and debts for the failing institutions. This method while playing a role in maintaining financial stability was not reliable because depositors would not be certain as to how, when and whether they would be reimbursed, such that any rumour on bank failure would automatically lead to a bank run and thereby accelerated insolvency among affected banks (Zhou, 2016). Furthermore, this system only catered for big banks, and therefore smaller banks were at a disadvantage. With the explicit deposit insurance system, all banks have an opportunity to be competitive because they are also protected under the deposit insurance system (Wei, 2016).

There are many similarities with the Chinese deposit insurance and that of other countries regarding objective and design. However, the country’s specifics differ. Regarding membership, the program in China applies to all deposit issuing financial institutions, which include commercial banks, rural credit cooperatives, and cooperative banks. However, an exception exists which are foreign banks and Chinese banks overseas. This is in contrast to other countries like Korea and the Philippines, which extend the coverage of deposit insurance to foreign banks, and domestic countries with foreign branches (Demirguc-Kunt, Kane, & Laeven, 2015)

Another contrast between China and other countries exists in the covered deposits. In China, deposits denominated in RMB and foreign currencies are insured. Inter-bank deposits by financial institutions and deposits by senior managers in their institutions are exempted (Desai, 2016). It is not yet clear if structured deposits are insured in the country. All deposit insurance authorities in Asia except Singapore, Japan Thailand, and Vietnam cover foreign currency deposits. The coverage level for Chinese depositors is limited to a maximum of US$ 76,000 pay-out amount. This coverage level differs considerably among different countries. The payout amount ranges from US$ 1,472 in India to US$ 146,789 in Indonesia as a result of historical and circumstantial differences. Contrast also exists in the mode of governance in that the China’s Financial Stability Bureau of the People’s Bank of China is tasked with managing the deposit insurance. Hong Kong and Singapore have privately administered deposit insurance authorities. China is different from other countries in Asia since its deposit insurance systems are independent of the country’s Central bank. Other contrasting differences exist in the mandate and insurance premium of different countries.

Even though there are differences in the adoption of the deposit insurance scheme between the countries, China as one the late adopters of the scheme might face similar problems as other countries in the way that banks might take on excessive risk which can potentially harm their financial stability. It therefore makes China an important case to investigate whether banks risk and other financial characteristics differ before and after the implementation of the deposit insurance scheme. This study aims to examine the differences in bank performance and risk-taking behaviour before and after deposit insurance system.

Chapter Summary

Deposit insurance has been considered an effective measure in enhancing bank performance, and this can be explained by their ability to cushion banks from negative effects of low liquidity that accompany financial downturns (Yang, Chun & Xie, 2016). Deposit insurance helps banks to effectively engage in their activities without worrying about possible losses, thus making them more productive. However, deposit insurance is not always associated with positive outcomes, and it has been known to increase the risk-taking behaviour among banks, thus increasing their financial risk in the event of a financial crisis. According to Schich (2008), the Deposit Insurance System (DIS) is a financial safety net that will play an important role in protecting China’s financial infrastructure through preventing bank runs and enhancing depositor confidence. Deposit insurance also leads to moral hazard, which according to Zhou (2016) is catalysed by the fact that insurance gives banks liberty to chase higher risk investments in a bid to gain higher yields, knowing that insurance will cover them in case of failure. This chapter provides valuable literature review that will be useful in guiding the research. 

Chapter 3: Methodology

3.1 Introduction

Appropriate methodology can ensure that greater accuracy and reliability of results is achieved. This research utilizes quantitative research to conclude the impact of deposit insurance on bank performance, based on comprehensive analysis of data. To collect data for the research, financial information from the selected banks is utilized, which is then analysed using a paired-samples t-test to determine possible changes in financial performance following the introduction of deposit insurance. This chapter justifies the approach adopted by the researcher and thus discusses the methodological approach, the research sample, data collection, variable definitions and data analysis method.

3.2 Methodological Approach

There are two broad approaches to research, which include qualitative and quantitative analysis (Saunders, Lewis, and Thornhill, 2012). Qualitative research aims at understanding phenomena through explorative studies that seek to understand experiences, behaviour, opinions, attitudes, and beliefs of the targeted population (Saunders, Lewis, and Thornhill, 2012). This data is then used to interpret various meanings and understand issues associated with the target population. Therefore, the qualitative research investigates social meanings, processes, interpretations, relations, and symbols. Data collection methods in qualitative research are unstructured, and questions are mostly open-ended (Yin, 2012). Responses are thus varied and vast due to different views and opinions. Quantitative data, on the contrary, involves the use of statistics in understanding the subject under study, where data collected is analysed through the use of statistical tests to make conclusions about the study (Yin, 2012). In quantitative research, research is utilized in testing a theory, which can then be supported or rejected (Quimby, 2012). Data collection in quantitative research is more structured, and there is the tendency of utilizing closed-ended questions, thus generating patterned responses (Yin, 2013).  Alternatively, secondary data may be collected through secondary sources such as books, journal articles, periodicals, reports, government publications and organizational records among others. In this study, data is collected from the banks’ financial reports. This study is based on the quantitative research methodology to examine the financial characteristics of banks before and after the introduction of the deposit insurance scheme in China. Quantitative research design is selected because of its ability to provide precise findings through statistical analysis, which will ensure that effective comparison can be conducted for the two periods (Yin, 2013).

There are two main reasoning in research: deduction and induction (Saunders, Lewis, and Thornhill, 2012). While the deductive technique moves from general to more specific hypotheses that can be tested, inductively begins with specific observations that lead to broader theories and generalizations. This study uses a deductive approach, whereby a theory is used to develop a hypothesis, and secondary data is used to test this hypothesis; ultimately confirming the original theory.

3.3 Research Sample

To obtain results from the research that can be generalized to other banks in the population, the sample for this study consists of the ten largest banks in China. The sample consists of the largest banks that are systematically important in China’s economy. These were selected based on their size, and the fact that the failure of these banks can estabilise the whole financial system in the country. It is therefore important to include these banks in the sample. The banks in the sample include three systemically important banks (SIBs) namely: Industrial and Commercial Bank of China, Agricultural Bank of China and Bank of China. Other banks include China Construction Bank, Bank of Communications, Shanghai Pudong Development Bank, China Minsheng Banking, China CITIC Bank, China Everbright Bank and China Merchants Bank.

3.4 Data Collection

The data for this study is collected from the financial reports of the banks included in the sample. This data consists of financial characteristics from the year 2012 to the first quarter of 2017. These years include the recent introduction of the deposit insurance system in March 2015 (Desai, 2016). To examine whether there is a difference in financial characteristics of banks before and after the introduction of Deposit Insurance, the study period is divided into two sub-periods: Before: 2012-2014 and After: 2015-2017. All data is collected for the year end, while data for 2017 includes data for the first quarter of 2017.

3.5 Variable Definition

In examining the impact of deposit insurance on bank stability, there are a number of variables that demonstrate a bank’s financial characteristics including liquidity, asset quality, capital and profitability. Among these, capital and liquidity are considered among the most important characteristics due to their centrality to bank stability and solvency (Farag, 2013). According to Farag, banks are in a better position to sustain losses and prevent insolvency when they maintain a higher capital and a favourable liquidity position.

To effectively measure the financial position of banks, various variables are examined as follows.

Liquidity Ratio

In this research, liquidity ratio is represented by the loan-to-deposit ratio, which is considered a highly relevant measure of bank liquidity.

Loan/deposit ratio – This is a liquidity ratio that denotes the percentage of loans in a bank against total deposits. As a measure of the funding profile of banks, a high ratio of loans to deposits could be an indication of a risky funding profile (Farag, 2013). As the loan-deposit ratio increases, a bank’s risk of insolvency is increased due to its worsened liquidity position. The percentage of loans to deposits is calculated by dividing the number of loans with the total deposits held over the year as follows:

LDR = Total loans      x 100

               Total deposits

Asset Quality Ratio

The quality of bank loans to a great extent influence bank risk and the type of loans given by a bank are therefore an important bank stability indicator. In the process of lending, the risk of default is always eminent and this explains why the quality of bank loans is of great significance. While banks may charge a higher interest for loans that are riskier, it is also notable that borrower riskiness may change over time and this makes it difficult to predict the performance of loans (Farag, 2013). One way to measure loan quality is the ratio of nonperforming loans held by a bank, which is also an indicator of a bank’s risk-taking profile.

Nonperforming loan (NPL) – This refers to a loan that is either in default or almost by default. Non-performing loans may comprise of loans whose principal repayment is overdue beyond three months, loans whose instalments payments are overdue beyond six months, loans where the debtor has been prosecuted as a result of non-payment or loans whose interest repayment has been overdue beyond six months ( A high number of nonperforming loans could indicate poor performance and could potentially lead to bankruptcy (Sophastienphong & Kulathunga, 2010). However, it is notable that this figure may represent loans given before the deposit insurance was introduced, hence an indication of prior risk-taking behaviour. To calculate the ratio of non-performing loans, the amount of non-performing loans is expressed as a fraction of the total loans as follows:

NPL ratio = Non-performing loans

    Total loans

Capital ratios

Capital plays a significant role in any bank by acting as a financial cushion against unexpected losses (Farag, 2013). The higher the capital a bank maintains, the more it can effectively absorb any losses the bank incurs. This means that capital has a direct influence on the bank’s stability or insolvency (Farag, 2013). It is however notable that by holding a large proportion of capital, banks may restrict their lending capability and thus reduce profitability (Kosmidou, 2008). In this research, capital is given significant consideration as a measure of bank performance and three measures of capital are incorporated as follows.

Tier 1 Capital (T1 Cap) – This measures the financial strength of banks and is considered a core measure of financial power. Tier 1 capital may consist of common stock, retained earnings and nonredeemable preferred stock among other core capital (Barth, Chen & Wihlborg, 2012). According To Basel III, Tier 1 Capital must not be less than 6% of risk weighted assets at any given time. Tier 1 Capital is calculated by adding Common Equity Tier 1 to additional Tier I (Bank for International Settlements, 2010). Additional Tier 1 capital may comprise of bank-issued instruments, stock surplus, instruments issued by consolidated subsidiaries of the bank and other regulatory adjustments (Bank of International Settlements, 2010). The formula for Tier 1 capital is given as follows:

T1 Cap = Common Equity Tier 1 + Additional capital.

Common Equity Tier 1 is defined below.

Common Equity Tier 1 (CET1) – This refers to the common stock that a bank holds. Introduced in 2014, the capital measure is a precautionary measure for protecting the economy by requiring banks to meet a specific CET1 ratio. (EBA, 2015). This is considered the highest quality capital and the ratio is similar to leverage ratio (Bank of England, 2014). According To Basel III, Tier 1 Capital must not be less than 4.5% of risk weighted assets at any given time (Bank for International Settlements, 2010). Common Equity Tier 1 is calculated as follows:

CET1 = common shares + stock surplus + retained earnings + other comprehensive

income and disclosed reserves + common shares issued by the bank’s consolidated subsidiaries + any regulatory adjustment in CET1 calculation.

Capital Adequacy Ratio (CAR) – This ratio is a measure of capital in a bank and is conveyed as a risk weighted credit exposure percentage (Sophastienphong & Kulathunga, 2010). To calculate the capital adequacy ratio, the formula is given as follows:

Capital adequacy ratio = Tier 1 Capital + Tier 2 Capital

 Risk-Weighted Exposures

The Risk-weighted exposures refer to the weighted total of a bank’s credit exposures, such that high risk-weight exposure could be detrimental to the capital adequacy ratio, thus influencing the bank’s financial position (Bank for International Settlements, 2010). 

The CAR seeks to ensure financial systems’ stability and efficiency and thus protect depositors. It measures tier 1 and tier 2 capital provided under Basel III to establish the degree to which the bank can withstand economic turmoil.

Profitability Ratio

Profitability remains an important indicator of bank performance. According to the risk-return trade-off hypothesis, higher risk may be linked to higher profitability (Kosmidou, 2008). Accordingly, this variable is considered highly significant in this study. Among the most commonly used profitability measures is return on equity which is discussed below.

Return on Equity (ROE) – This is considered an important profitability ratio and is used in measuring the proportion of income returned as equity for shareholders (Barth, Chen & Wihlborg, 2012). This ratio indicates how effectively a corporation can generate profit from what shareholders have invested. The formula for ROE is give as follows:

Return on Equity (ROE) = Net Income    

Average total equity

The higher the ROE, the more effective a company is said to be in terms of using equity financing for net income generation (Barth, Chen & Wihlborg, 2012). An ROE of 1 for example would mean that one dollar is generated in net income for every dollar invested by stockholders. Based on the risk-return trade-off hypothesis, banks would gain higher profitability through increased risk. On the contrary, an increase in non-performing loans could affect income and thus reduce profitability (Kosmidou, 2008). In this respect, the relationship between risk taking behaviour and profitability may not always be straightforward.

The bank financial characteristics described above are used in examining whether there is a difference in bank risk profile before and after the introduction of deposit insurance scheme in China in March, 2015.

3.6 Data Analysis

Data for this research is analysed using SPSS using Paired (Dependent) Samples T test. The dependent samples t-test is used in the comparison of means (e.g. financial characteristics) between two groups that are related (such as same entities at different time points) (Laerd Statistics 2017). In this research, the aim is to determine the influence of deposit insurance on bank stability in China. Accordingly, the samples are split into two sub-samples in a bid to compare bank performance between two economic periods, before and after the introduction of the deposit insurance scheme. The t-test is used in analysing the data between 2012 and 2014, and comparing it to data between 2015 and 2017; given that March 2015 is when the deposit insurance system was put in place.

3.7 Chapter Summary

This chapter describes the research methodology adopted for the research. A quantitative approach is adopted in conducting the research, where financial data from banks is used in the analysis. The 10 largest banks in China are selected for the collection of data. Information from their financial records including loan-to-deposit ratio, nonperforming loan ratios, Tier 1 Capital, Capital Adequacy Ratio, Return on Equity. To compare the periods before and after the deposit insurance, the dependent samples t-test is utilised. The research methodology attempts to ensure that accuracy of research is achieved and that the conclusions are reliable. In the next chapter, the results and data analysis are presented.

Chapter 4: Data Analysis

4.1  Introduction

In this chapter, the results of the research and data analysis are presented. The analysis aimed to determine the impact of deposits insurance on banks’ performance and risk-taking behaviour, as indicated in the initial objectives of the research. The analysis first shows the descriptive statistics of the two related samples (bank characteristics before and after the DIS introduction). The following step is to conduct a paired samples t-test that attempts to compare the financial data of banks (liquidity, asset quality, capital and profit) before and after the deposits insurance was introduced.

4.2  Descriptive statistics

Data from the 10 banks indicate a change in bank financial performance before and after the introduction of deposit insurance system in China. The results are illustrated through the various financial ratios as follows.

Risk-Taking Behaviour

Loan-to deposit ratio

The loan-to-deposit ratio among all the banks increased considerably from the year 2012 to 2017. This means that there was an upward trend both before and after the deposit insurance system. While the average loan to deposits in the year 2012 for all banks was at 70%, this increased to 78.46% in 2016 before dropping slightly to 78.4% in 2017. A time series showing the changes on liquidity before and after the introduction of deposit insurance in China is shown below.

Nonperforming loans

Overall, there was an increase in the number of non-performing loans, both before and after the introduction of deposit insurance system. It is however notable that the increase in non-performing loans was higher before the deposit insurance system, having increased by 47% between 2012 and 2014. On the contrary, the increase following the deposit insurance system between 2015 and 2017 was 3.09%. ABC had the highest value of non-performing loans in 2017, the last year of evaluation at 2.33% while BOC had the lowest value at 1.45%. The changes on non-performing loans before and after deposit insurance is illustrated below.   

Bank Stability

Capital ratios

Capital is considered an important aspect in assessing bank performance. As illustrated in the graph below, Tier 1 Capital increased both before and after the deposit insurance system. The Tier 1 Capital increased by 5.6% while it increased by 1.53% after 2015 when the deposit insurance system was introduced. In calculating the Tier 1 Capital before the deposit insurance system, the comparison was done between 2013 and 2014 because data for Tier 1 Capital in 2012 was only available for one bank. Common Equity Tier 1, a significant measure of capital for banks increased gradually in the entire period of study. Before introduction of the deposit insurance CET1 increased by 12.02%. On the other hand, the capital measure in increased by 0.43%. Notably, the CET1 declined in 2016 from 6.96% in 2015 to 6.78%, before increasing again to 6.99%. The third capital ratio, Capital Adequacy Ratio showed an oscillating trend, with figures dropping in 2013 and 2016 while increasing in the other years. The percentage increase recorded in 2014 from 2012 was 1.03% while the increase recorded in 2017 from 2015 when the deposit insurance system was introduced was 1.39%.

Bank Performance


Profit ratio was represented by return on equity (ROE), with the results indicating that the ratio fell following the introduction of the deposit insurance system. While the ROE was 21.82% in 2012, this fell considerably to 16.22% in 2017. The ROE fell by 14.52% between 2012 and 2014. Following the introduction of the deposit insurance system, in 2015, there was a 10% decrease in ROE in 2016 before the value returned to the 2015 figure.   

The net profit for all the banks included in the research improved between 2015 and 2016, except for BOC whose profit dropped in 2016. The increase in profitability is an indication of better performance. In the graph shown below, the net profitability trend for each bank is shown, including the profit figures for each year.

Minimum and maximum statistics

The tables below represent the minimum and maximum statistics for the difference in the two samples including skewness and kurtosis. The paired sample t-test relies on the means determine the difference in the two time periods.

Table 1: Minimum and maximum statistics _before and after

Standard Deviation0.06130.00240.01300.01090.00710.0288
Standard Deviation0.06650.00260.01340.01660.00800.0217

Table 2: Minimum and maximum statistics differences

Loan DifferenceNPL DifferenceCAR DifferenceT1 DifferenceCET1 DifferenceROE Difference
Standard Error0.0069630010.0004546740.0016440270.0022621620.0012017780.004179696
Standard Deviation0.0381379280.0024903510.0082201340.0103665280.0065824090.022893139
Sample Variance0.0014545026.20185E-066.75706E-050.0001074654.33281E-050.000524096

4.3 Impact of deposit insurance on China banks’ risk-taking behaviour

The results from the paired samples t-test show that Chinese banks have undergone changes from the introduction of deposit insurance as evidenced by the change in their risk-taking behaviour. Based on the data collected from the 10 banks, the variables change considerably over the years, and this can be interpreted as follows. 

Loans to deposits ratio

Loan to deposits ratio is a measure of liquidity and the funding profile of banks, where the higher ratio indicates a riskier funding profile (Farag, 2013). The results show that the average figure increased significantly following the deposit insurance. While the average loan to deposits in the year 2012 was at 70%, this increased to 78.46% in 2016 before dropping slightly to 78.4% in 2017. The p value based on the paired t-test 0.00, a figure less than 0.05 and which shows a significant difference in the conditions before and after the deposit insurance. When the loans to deposits ratio are high, it is a manifestation of a risky funding profile (Farag, 2013). This insinuates that following the deposits insurance, the ratio of loans to deposits has increased, which indicates that banks’ risk propensity increased to a considerable level. According to Tan (2016), there is a lower risk of loss when insurance is present, and this reduces cautionary measures taken by banks such as limiting credit facilities and offering risky loans. This could be the case in China where the loans to deposits ratio have continued to increase following the introduction of deposit insurance. In a similar research, Calomitis & Jaremski (2016) established that in the presence of deposit insurance, firms were more risk-taking and used more of the deposits received to expand their lending. In this relation, the study associates such risk-taking behaviour with a possible increase in losses in the future.

Nonperforming loans

Non-performing loans increased from 0.83% in 2012 to 1.7% in 2017. The p value resulting from the paired t-test to compare the period before and after the introduction of deposit insurance in China is valued at 0.001. This can be directly related to the introduction of deposit insurance, which leads to higher risk-taking behaviour among banks. In a research by Ioannidou and Penas (2008), it was established that in the presence of deposit insurance, banks were more likely to engage in riskier lending, initiating loans to more risky borrowers. This group of borrowers has a higher chance of failing to pay back their loans and as banks lend more without paying attention to repayment risks, the probability of having increased non-performing loans is higher. Accordingly, it can be established that banks in China had a higher risk-taking behaviour in the period following the deposit insurance regulations. This corresponds with the findings by Ioannidou and Penas (2008) who establish that deposit insurance increased the risk appetite among banks, demonstrated in this research by the high number of non-performing loans recorded by the banks under study. When banks are assured of a back-up to protect their liquidity in the event of an economic downturn, they tend to exercise lesser caution in their lending activities, which can explain the high number of non-performing loans witnessed among banks in China. To a significant extent, however, it may be difficult to determine, based on the data whether all losses from non-performing loans were from loans taken after the introduction of the deposit insurance system. It is however difficult to establish whether the non-performing loans recorded are the result of riskier lending behaviour among banks because it is possible that some loans may have been given before the introduction of deposit insurance.

Capital Adequacy Ratio

CAR rose slightly over the years, from an average of 11.73% in 2013 to 13.17% in 2017. This would generally indicate availability of more capital for banks to cover their losses such as those resulting from non-performing loans, hence more resilience to risks. This is contrary to the expectation that deposit insurance introduction would lower capital ratios since banks would adopt riskier behaviour (Kim, Kim & Han, 2014). However, this can also be explained by the fact that banks are now required to maintain a higher Tier 1 capital to improve economic resilience. In China, the ratio for top banks is currently set at 11.1% and is expected to increase to 11.5% by 2018 to meet the Basel III requirements ( Results from the t-test indicated that there was a significant difference in capital adequacy ratio after the introduction of the deposit insurance system (p value = 0.000). Capital adequacy ratio determines how well a bank can survive economic downturns and it is therefore evident that Chinese banks are in a better position to maintain their operations in case of economic crisis. A rising trend is an indication of enhanced financial stability, and as noted by Hull (2015), the capital adequacy ratio can indicate a bank’s financial strength based on the fact that the bank can handle its obligations more effectively in the event of financial difficulties.

Tier 1 Capital and Common Equity Tier 1

On average, the Tier 1 Capital increased from 9.29% to 10.60% in 2017 while Common Equity Tier 1 increased from 5.99% to 6.99% during the same period. The paired t-test results indicated a significant difference in Tier 1 Capital and Common Equity Tier 1 before and after the introduction of deposit insurance system. While the p-value for T1 Cap was 0.007, CET 1 was valued at 0.000. Both of these values are less than 0.05 and therefore an indication of a significant difference between the variables before the introduction of insurance deposit and after. This insinuates that deposit insurance could have improved the performance of banks in China based on their capital structure following the regulation. The values of T1 Capital of CET 1 increased considerably following the deposit insurance introduction. The increase may be associated with China’s requirements, which aims at reaching a Tier 1 capital adequacy ratio of 9.5% and a Common Equity Tier 1 capital ratio of 8.5% by 2018 ( This is in order to meet Basel III requirements and also increase the resilience of banks against financial crisis. An implication of this for commercial banks in China is that they are in a better position to cushion them from insolvency in the event of a bank run. Hull (2015) notes that the increased requirements of Tier 1 Capital and Common Equity Tier 1 was aimed at increasing banks’ resilience to ensure that they can effectively go through financial challenges. Tier 1 Capital measures the financial strength of banks and is considered a core measure of financial power. This includes capital from a common stock, retained earnings and nonredeemable preferred stock among other core capital that may be used in redeeming a bank during financial turmoil (Bank of International Settlements, 2010, 2010). Common Equity Tier 1, on the other hand, is also an indication of financial strength and does the bank hold a capital measure that represents the common stock. Such capital may shield a bank from unexpected losses and insolvency and is thus considered a major capital strength for any bank. This means that banks may successfully avoid a bank run by using the capital and common equity, thus maintaining its financial position. The increase in Tier 1 Capital and Common Equity Tier 1 capital among Chinese banks may explain the absence of bank runs following the deposit insurance system in China.

Return on Equity

Return on equity is seen to decrease following the deposits insurance, an indication that bank performance may be deteriorating. While the average ROE for all banks as at 2012 and 2013 was 21.82% and 20.64 respectively, this dropped gradually to 14.57% in 2016 before improving to 16.22% in 2017. It is however notable that the net profits for all the ten banks increased during this period as shown in Appendix 1. The result of this study show that nonperforming loans increased over this time period and thus could have an impact on bank profitability. Therefore, increase in nonperforming loans and the requirement to maintain a higher Tier 1 Capital and Common Equity Tier 1, could have influenced the drop in ROE. The risk-return trade-off hypothesis suggests that as banks take higher risk, they are likely to record an increase in profitability (Kosmidou, 2008). On the contrary, Kosmidou (2008) notes that if nonperforming loans increase as a result of the risk-taking, a negative effect on bank income and thus reduce profitability to a considerable extent. This may explain the decrease in ROE following the introduction of the deposit insurance system. In addition, profitability may not be immediate due to time lag, such that a reduction in ROE is observed when it would be expected to be rising.

4.3 Analysis of Indicators using paired sample t-test

A further analysis of the ratio change patterns is done using the paired sample t-test. The test compares the bank ratios before and after the introduction of deposits insurance. Results in table 3 indicate a p-value of less than 0.05 for all the six pairs tested as shown in the figure below (sig. (2-tailed). When the p-value is less than 0.05, it is an indication that the existence of a certain condition could have led to changes in the results. In this case, there is evidence that the means of the variables of the two samples (before and after) are different, suggesting that the introduction of deposit insurance had an impact on the six variables included in the research. This means that all the variables changed following the deposit insurance requirement. It is however notable that the changes observed may not entirely be as a result of deposit insurance introduction, given that there are many factors influencing the variables. Higher requirement of capital for example could lead to a change in capital ratios rather than deposit insurance, hence the caution in data interpretation.

Table 3: Paired sample test before and after

Paired Samples Test 
 Paired Differencest-testSig. (2-tailed) 
Risk-taking behaviour    
Pair 1Loan_Before – Loan_After-5.85667%-8.411.000 
Pair 2NPL_Before – NPL_After-0.66433%-14.611.000 
Financial stability    
Pair 3CAR_Before – CAR_After-0.77680%-4.725.000 
Pair 4T1Cap_Before – T1Cap_After-0.68238%-3.016.007 
Pair 5CET1_Before – CET1_After-0.559148%-4.653.000 
Pair 6ROE_Before – ROE_After4.70067%11.246.000 
  Paired Samples Test 
 Paired DifferencestSig. (2-tailed) 
Risk-taking behaviour    
Pair 1Loan_Before – Loan_After-5.85667%-8.411.000 
Pair 2NPL_Before – NPL_After-0.66433%-14.611.000 
Financial stability     
Pair 3CAR_Before – CAR_After-0.77680%-4.725.000 
Pair 4T1Cap_Before – T1Cap_After-0.68238%-3.016.007 
Pair 5CET1_Before – CET1_After-0.559148%-4.653.000 
Pair 6ROE_Before – ROE_After4.70067%11.246.000 

Year-by-year comparison of means

One of the assumptions of the paired samples t test is that observations are independently and identically distributed ( Since our sample includes same banks in different years, this assumption might not hold. Therefore other tests were performed but using two years only:

  • A year before (2014) and at the end of the year when DIS was introduced (2015);
  • A year before (2014) and one year after the event (2016).

A similar trend is observed in the paired test comparing 2014 and 2015, where the p-value from the paired sample test is less than 0.05. This means that there is evidence that the deposit insurance requirement had an impact on all the variables studied during the period.

Table 4: Paired sample test 2014-2015

Paired Samples Test 
 Paired DifferencestSig. (2-tailed) 
Pair 1Loan_2014 – Loan_2015-2.10923%-2.927.017 
Pair 2NPLs_2014 – NPLs_2015-0.40300%-6.460.000 
Pair 3CAR_2014 – CAR_2015-0.25100%-1.632.137 
Pair 4T1Cap_2014 – T1Cap_2015-0.44400%-2.932.017 
Pair 5CET_2014 – CET_2015-0.248936%-2.409.039 
Pair 6ROE_2014 – ROE_20152.43600%13.652.000 

In the 2014/2016 pair, however, the p-values are greater than 0.05 for capital adequacy ratio, Tier 1 capital and common equity tier 1 as indicated in the table below. This indicates that no significant difference was observed during these years as a result of the deposit insurance requirement. A further investigation into the variables reveals that there was a drop in the three variables in the year 2016 from the figure recorded in 2015, hence explaining the differences in t-test results. The difference in results between the 2014/2015 and 2014/2016 paired tests could be an indication that changes in the banking sector may not be consistent; implying that there are other forces in the economy which may have influenced bank performance besides deposit insurance.

Table 3: Paired sample test 2014-2016

Paired Samples Test 
 Paired DifferencestSig. (2-tailed) 
Pair 1Loan_2014 – Loan_2016-4.8%-3.94.003 
Pair 2NPLs_2014 – NPLs_2016-0.48%-8.004.000 
Pair 3CAR_2014 – CAR_2016-0.204%-1.448.182 
Pair 4T1Cap_2014 – T1Cap_2016-0.311%-1.351.209 
Pair 5CET_2014 – CET_2016-0.068%-0.679.257 
Pair 6ROE_2014 – ROE_20164.084%15.92.000 

Capital adequacy ratio

4.4  Discussion with literature

Overall, the results from the tests show that the financial performance of banks was affected by the introduction of the deposit insurance system. The results indicate that there is a significant difference between variables before and after the introduction of the deposit insurance system in China. These are discussed in relation to literature as follows.


Liquidity is considered one of the main features that deposit insurance attempts to safeguard. The results of this research indicate that there was an increase in loans-to deposit ratio which represents liquidity following the introduction of deposit insurance system. This can be explained by an increase in risk-taking behaviour among banks as a result of deposit insurance introduction. Deposit insurance increases banks’ confidence to lend because they are assured of a back-up in the event of financial difficulties or a bank run (Allen, Carletti & Leonello, 2011). Similar studies have also established that the loan-to-deposit ratio is likely to increase after deposit insurance introduction. According to Kim, Kim & Han (2014), deposit insurance leads to advancement of more loans by banks due to the higher risk-taking behaviour. Banks are more confident in issuing loans because they are assured of support from insurance in the event of a bank run. This is also associated with moral hazard, where banks take risks knowing that insurance will shield them against risk (Allen, Carletti & Leonello, 2011). The higher the risk taken, the more profitability is expected through increased lending, which could explain banks’ behaviour following the introduction of deposit insurance system (Calomiris & Jaremski, 2016).

Asset Quality

The results of this study show that the nonperforming loans increased following the introduction of the deposit insurance system. This could be an indication of increased risk-taking among banks due to the security offered by deposit insurance. According to Ioannidou, VP & Penas (2010) and Anginer, D., Demirguc-Kunt & Zhu (2014), banks take greater risks when their deposits are insured more than when they are not. However, a major implication of enhanced risk-taking is an increase in non-performing loans, which impacts the quality of a bank’s assets. The higher the number of nonperforming loans, the higher the risk of dissolution in the event of financial crisis (Barth, JR., Chen, L & Wihlborg, 2012).


The results of the research show that capital among banks increased following the deposit insurance introduction. The expectation after the introduction of deposit insurance is that banks would take higher risk and thus advance more loans; thus decreasing the level of capital among banks (Bonfim & Kim, 2013). The explanation for such a change according to Barth, JR., Chen, L & Wihlborg (2012) is that when banks lend more, less capital is left to cater for any financial risks that may be anticipated, which generally puts banks at a greater risk. In this regard, deposit insurance is seen as a threat for bank capital if regulatory measures are not undertaken. The rising level of capital in this research can be explained by the regulatory measures put in place to protect bank capital under Basel III; including the Tier 1 Capital and Common Equity Tier 1 Capital (Bank of International Settlements, 2010). These two capitals are aimed at protecting banks from financial crisis by ensuring that banks can effectively cushion losses resulting from difficult economic times (Gomes, T & Khan, 2011). While there was an increase in capital, this may be more as a result of the regulations as opposed to the deposit insurance.


The introduction of deposit insurance may influence profitability through the risk trade-off hypothesis as suggested by Kosmidou (2008), where banks increase their risk-taking, advance more loans and hence obtain increased profit. The results of this research however indicate that the return on equity, which represents profitability in the research reduced during the period of study. There are two explanations for this, with the first lying in the risk trade-off hypothesis, such that if the bank’s increased risk leads to higher nonperforming loans, the bank may end up making more losses. This could be the case for Chinese banks given the rising value of nonperforming loans. The second explanation could be a lag in profitability increase. Grant (2016) notes that introduction of a new strategy within an organization may not always yield immediate profitability and may take time to adjust. In this case, the deposit insurance system was introduced in 2015 and profitability adjustments may still be taking place.

4.5  Chapter Summary

This chapter describes the results of the research, thus answering the research questions that it sought to answer. The analysis is done using SPSS, specifically the use of paired t-test in answering three questions as follows: Has deposit insurance reduced the number of bank runs in China? How deposit insurance enhanced the financial stability of Chinese banks? The results determine that during the period of research, none of the ten banks included in the research had a bank run. Also, there was only one potential bank run that did not materialize, which was as a result of false rumors, an indication that deposit insurance regulation is effective in reducing the possibility of bank runs in China. The results also indicate that bank performance has increased and that the risk-taking behavior among banks has also increased. These results are based on the paired t-test, which indicates that there is a significant difference between the study variables in the period before and after the introduction of deposit insurance. The analysis chapter is the basis for the research conclusion, and the findings demonstrate the outcome of the research.

Chapter 5: Conclusion

5.1 Introduction

Bank runs are considered among the various impacts of financial crises, and which have the potential to lead to bank insolvency as customers rush to withdraw their savings within a short period. Following the financial crisis of 2007/08, a significant number of countries adopted the deposit insurance system as a means of safeguarding banks in the event of financial crisis. This research sough to determine the impact of deposit insurance introduction on banks in China, by comparing the period before and after introduction of the deposit insurance system. To achieve this, data from top 10 banks in China was collected and analysed based on various variables namely liquidity, asset quality, capital and profitability. Under each variable, different indicators were used to determine whether there was a difference in the variables before and after the introduction of the insurance deposit system. The results were analysed using SPSS software, through the paired sample t-test.

5.2 Summary of main results

This research establishes that deposit insurance plays a role in influencing the risk-taking behaviour of banks. This was observed through an increase in loan-to-deposit ratio, higher non-performing loans and lower return on equity. As evident in existing literature, deposit insurance leads to an increase in risk-taking among banks, which in return leads to increased lending with higher risk. As the number of nonperforming loans increase, the company has to sustain more losses and this means that their profitability is likely to reduce. The ratio of loans to deposits has increased over time, and this is a demonstration for increased risk appetite among banks. This can be associated with the assurance that deposit insurance offers, such that banks are more likely to engage in high-risk lending without fear of failure. A high loans to deposits ratio indicates a risky position for banks and this could potentially lead to insolvency. The increase in some non-performing loans is also an indication of the heightened risk-taking behaviour among banks in China following the deposit insurance system introduction. When banks increasingly lend to risky borrowers, they risk the possibility of high default rates, and this could compromise their financial position.

The level of capital held by banks has also increased considerably, and this increases their resilience in the event of a financial downturn. This means that banks in China are in a better position to survive and avoid bank runs. The deposit insurance system however may not be directly related to the increase in capital, which is considered to be the result of Basel III regulations which require banks to increase their capital level in order to effectively survive economic crises. The results of this study resonate with previous researches such as Allen, Carletti & Leonello (2011), Zang, Cai, Dickinson & Kutan Zhou (2016), Otgonshar & Otgonshar (2013) and Ioannidou & Penas (2010) who study the impact of deposit insurance and determine various implications including enhanced financial performance of banks, reduced likelihood of bank runs and increased risk taking behaviour among banks. The findings are not only true in other regions, but this research also establishes that these are some of the implications of deposit insurance in China.

5.3 Implications

This research has significant implications on banks in China, the China government and other countries seeking to adopt the deposit insurance system. The results of the study provide imperative conclusions about the effect of deposit insurance system among banks in China. These can be used by featured banks to keep track of the changes in their indicators in order to ensure that they moderate their risk-taking. A comparison of the variables with other banks can provide valuable information for banks to determine their competitive position. The government can use the results of the study to determine the impact of the deposit insurance system and thus determine whether it is yielding the intended results. This would help in developing measures to prevent any adverse effects. An example is the high risk taking behaviour of banks and consequent moral hazard, which could potentially lead to increased financial risk among banks through nonperforming loans. This could be addressed by setting a minimum lending rate to prevent high risk loans. Other governments could learn from significantly from this research through understanding the implications of the deposit insurance system and how it can help in promoting bank stability.

5.4 Limitations and Recommendations

This research makes use of the top 10 banks in China and while they provide adequate information to answer the research questions, they are a relatively small sample and may not be a representative of the entire population. This is mostly so because there are no small banks included in the research. The recommendation for future studies is to increase the sample size and also include banks of various sizes.

The paired sample t-test determines that there is a difference in the means of financial characteristics of the banks included in the research. It is however notable that the ratios analysed are subject to influence by other factors within the economic environment. This means that some variables may have been influenced by other factors other than deposit insurance system; which makes it difficult to determine whether the results were an effect of deposit insurance introduction or other factors. An example is the Basel III regulations in capital, which could be responsible for an increase in capital between the two time periods. To counter this, future researches could implement more advanced techniques such as regression analysis where dependent variable could be probability to default. The researched could also include other ratios such as liquidity coverage ratio in measuring risk-taking behaviour.

5.5 Final Conclusion

In conclusion, the deposit insurance in China has had a considerable impact on banks regarding performance, bank run avoidance and risk taking. The research effectively establishes that banks have improved their performance as indicated by the increased profitability. Regarding bank runs, China has not experienced any major bank run in the recent past and the absence of bank runs following the introduction of deposit insurance is an indication that banks are maintaining a sustainable financial position. It could insinuate that banks have benefited from deposit insurance over the years, which has prevented them from undergoing financial difficulties. About risk taking, the higher propensity for risky lending among banks is apparent as indicated by the increase in the ratio of loans to deposits and the high number of non-performing loans possessed by the banks. The research, however, establishes that while deposit insurance may have influenced changes in the variables studied, other factors in the business environment including market changes, increased costs, changes in demand for loan facilities and other regulations may have impacted some of the changes witnessed. The increase in reserve capital, for example, is also influenced by the government’s requirement for banks to maintain a standard Tier 1 capital and common equity tier 1 capital. Overall, the introduction of the deposit insurance system has played a key role in enhancing the financial stability of banks in China and could be highly effective in preventing bank runs. On the contrary, an increased propensity for risk-taking based on the existence of insurance may result in instability in the banking sector and thus lead to potential bank runs in the future if not effectively checked.

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Adjusted Gross Income Assessment

Inclusions, Exclusions, and Adjusted Gross Income Assessment


Determining a taxpayer’s taxable income is a complex process. A tax paper is required to deduct specific deductions from their gross income to determine the adjusted gross income (AGI). The adjusted gross income thus determined is then deducted allowances for personal exemptions and deductions that have been itemized to arrive at the taxable income for the period (Salisbury, 2016).

A person’s gross income includes one, some or all income earned from business, rental properties, interest, dividends, wages and alimony payments received from a former spouse, capital gains from assets owned and income earned from self-employment among others .  Tax payers are permitted by the United States of America Congress to make certain deductions from their gross income to determine their adjusted gross income (AGI).  The specific deductions have been identified in Form 1040 issued by the Internal Revenue Service (IRA) (Klemens, 2006).

Adjusted gross Income (AGI) Legislation

The US Congress has permitted various deductions from a taxpayer’s gross income to determine the adjusted gross income (AGI) in a bid to make taxation fair and equitable throughout the country. These deductions are referred to as “adjustments to income” or “above-the –line deductions” and are subject to change every year by the US Congress.

If trade or business carried out by a company does not constitute performance by a taxpayer as an employee, the Internal Revenue Service allows above-the-line-deductions for related expenses that are ordinary and necessary(Salisbury, 2016). These include allowance for salaries for personal services rendered to the company, travelling expenses while looking for new business and rental payments made by a taxpayer for a property for which he has not taken a title or has no equity and is done for purposes of ensuring that the business continued operating (Klemens, 2006). 

One of the deductions that have been allowed is educator expenses. Educator expenses is one of the adjustments to income also known as “above-the-line deduction” allowable by the Internal Revenue Service for purposes of computing a taxpayer’s adjustable gross income (AGI) for tax purposes (Salisbury, 2016).

Educational expenses are expenses incurred by eligible educators for participation in professional development courses and materials used in a class room such as computer equipment both hardware and software, books, supplies and other supplemental materials for use in a class room setting. Grade 12 teachers, instructors, counsellors, principals and their aides are some of the professionals classified as educators for tax purposes.

The next above –the –line deductions for determining a taxpayer’s AGI is contributions made to a traditional individual retirement account (IRA). Tax payers do not have to pay tax on IRA accounts because they are tax-deferred. Interest or any other gain made from such accounts is exempt from tax purposes (Salisbury, 2016).

The next item allowable for above-the –line deduction is interest paid on loans taken by students. The next above-the – line deduction are costs incurred by a tax payer to move to take a new job in a different location. This is allowable only if the move from the previous job is more than 50 miles away.

The next above-the-line deduction is alimony payments to a former spouse. Alimony payments are only allowable when they are made under a divorce or separation instructed pursuant to a court judgement (Chodorow, 2011).  The recipient of the alimony payment is required to include the amount in their income for tax purposes. Other above-the-line deductions include business expenses incurred by teachers, fee-basis government officials, performing artists and reservists, deductions made on health savings accounts, one half of tax on self-employment, domestic production activities deductions and jury duty pay that is paid to the employer of the juror among others (Ruff, 2007). Adjusted Gross Income.

Justification for the exemptions to taxpayers by the US Congress

There are various reasons which could have informed the decision by the US Congress to grant these exemptions to taxpayers.  The first reason is that the US Congress ensured that there is equity and fairness in tax payments to the Internal Revenue Service. Exemption on alimony payment protects the recipient from having to pay taxes twice on the same income (Salisbury, 2016).

This is because the recipient is taxed on the amount received as alimony income and so if the payer is also taxed then that would be tantamount to double taxation on the same income. The US Congress by granting the exemptions ensured taxes are broad based as to include as many people as possible. This was aimed at ensuring the government generates adequate revenues to meet its financial obligations.  The exemptions were also aimed at minimising tax burden on the individual tax payer (Reichert, 2016).

By exempting one half of tax on self-employment, the US Congress ensured that self-employed people are not overtaxed sine their employed counterparts get part of their tax revenues met by their employers. By granting the exemptions, the Congress ensured taxes are enforced in a manner that facilitates voluntary compliance by a wide range of taxpayers.

The exemptions are meant to communicate the message that the government is fair in its tax collection and that no one is unfairly treated in tax payment (Koch, 2011). This encourages tax payers to pay taxes willingly without compulsion or coercion from the tax authorities.  The exemptions were also made to ensure tax collection was efficient and hence achieved its overall objectives.

The exemptions was aimed at minimizing the cost of tax collection as the exemptions are easy to understand and apply in determining the adjustable gross income. The exemptions were also aimed at ensuring equity in tax application such that no particular citizen or group of citizens could perceive themselves as bearing an unequal burden of paying taxes as compared to other groups of citizens in the USA (Chodorow, 2011).

 The US Congress was also motivated by the desire to ensure taxes were administered in a neutral manner. The exemptions were meant to ensure that no race, group or sector was favoured by taxes over another and that no group, sector or race could use taxes as the basis for collective or individual decision making in either investment, social life or any other matter. 

The exemptions were also aimed at ensuring taxes were predictable and inevitable to ensure tax payers have information before hand to enable they pay taxes on time and without coercion from the Internal Revenue Service (Klemens, 2006).  The Exemptions could also have been undertaken with the aim of achieving certain objectives.  For instances, exempting interest on student loans could have been motivated by the aim of encouraging young people to pursue higher education without the fear of incurring huge debts by the time they finish their studies.  

Educational expenses exemption on eligible educators for participation in professional development courses and purchase of materials used in class rooms such as computer equipment both hardware and software, books, supplies and other supplemental materials could have been motivated by the desire to grow investment in education. By giving exemptions for educator expenses, the congress encouraged investment in schools and colleges to improve accessibility and quality of education in the sector (Klemens, 2006).

 The exemptions could have been motivated by a desire to ensure tax administration was simple foe every tax payer to understand. Adjusted gross income to be considered. This encouraged compliance and improved willingness of taxpayers to pay taxes on time and reduce tax evasion.  The exemptions were also aimed at fostering fair and equitable distribution of wealth in the country. By ensuring no tax payer was billed for more than their fair share of taxes, the congress ensured that people retained their fair share of gross income. This ensured income will be distributed equitably with the country (Klemens, 2006).

Additional exemptions that can be challenged easily

Even though the US Congress has granted various exemptions, there are various exemptions that can easily be challenged. One of the exemptions that can be challenged is exemptions on educator expenses. Educator expenses that can be challenged include participation in professional development courses, books, supplies and supplemental materials. Schools, colleges and universities charge students fees at market rates and even where they are given grants and donations, they are given on budgets which have been prepared beforehand.

By granting exemptions, the congress is favoring one sector over others. This is because these expenses are factored in the financial statements of the schools they work for. Most educational institutions that employ educators are also for profit making and hence giving exemptions will only increase their revenues (Chodorow, 2011).  

On the other hand, costs that educators incur on attending personal development courses are ideally aimed at enhancing their knowledge, skills and competencies. The educators henceforth are able to assume bigger responsibilities and earn higher incomes. By exempting educator fees, the revenue service is ideally granting educators in one profession better terms that their counterparts in other sectors.

Exemptions in alimony payment to a former spouse is another exemptions that can be challenged (KATZEFF, 2011). This is mainly because alimony payments occur as a consequence of breakup of the family unit. This exemption encourages couples to break up to earn alimony income from a former spouse. It common in the country to find one spouse earning alimony income from multiple former spouses. This is likely to lead to laziness as many people will opt for his revenue source instead of working hard to generate their own income. This exemption encourages families to break up and take their marriages to court to have the divorces registered for alimony payment (KATZEFF, 2011).

Exemptions on interest on student loans is also another ill-advised exemption.  Exempting interest on student loans ignores the effect of passage of time on the value of money. Money lend to students loses value due to passage of time due to inflation and other factors. The interest is supposed to compensate for the effects of inflation on the time value of money. Giving exemptions to performing artists is unfair as what they earn inform of income is similar to what other professional also earn from their professions (Koch, 2011).

Additional exemptions that are agreeable

There are various additional exemptions that US Congress has granted that are agreeable. One of the more agreeable exemptions is deductions on medical and dental expenses more than 7.5% of a taxpayer’s adjusted gross income. This expenditure is agreeable because it promotes the health of tax payers and it is classified as below-the –line deduction.

Health saving account deductions are agreeable because the funds saved will improve accessibility of healthcare services to all Americans and especially the most vulnerable members. Moving expenses are agreeable because they reduce the living standard of the tax payer at the time of moving without increasing their disposable income. This exemption is therefore agreeable (KATZEFF, 2011).

 Deductible part of self-employment income is agreeable because this exemption goes a long way in promoting entrepreneurship in the country. With the rising numbers of unemployed people who are employable, any efforts to promote self-employment would assist in reversing unemployment in the country.  The exemption on penalty for early withdrawal of savings is also an agreeable deduction. This is mainly because the penalty levied is punitive to the taxpayer and taxing him again would be being unfair on the part of the internal revenue service (Chodorow, 2011).


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