extensively documented cases of 18<sup>th</sup> Century Scotland and early 19<sup>th</sup> Century New England (Kroszner, 1997; Lamoreaux, 1994).

# _Evidence_

There is a growing body of evidence (since Baer and Brewer, 1986) on the negative correlation between various indicators of bank quality and interest rate paid for deposits and a positive correlation with deposit growth.

The major route for depositor discipline is through withdrawal. Probably the biggest episode of deposit withdrawals in recent times was the loss of one-fifth of the deposit base in the Tequila crisis of 1994-5 in Argentina. Calomiris and Powell (2001) cite evidence that it was the banks that were objectively weaker and those which subsequently proved to be insolvent that were the subject of the most severe withdrawals, suggesting that this form of depositor discipline can be a discriminating one, and is not necessarily caught up in a contagious race for all exits, even in such a systemically grave crisis (see also D’Amato, Grubisic, and Powell, 1997).

Withdrawal can also be permanent. If informed large depositors remain persistently dubious about the quality of bank governance, then they will stay away – even placing their funds outside the country.<sup>3</sup> Depositors do seem to demand higher returns from risky banks. Although many of the earlier US studies found little relation between measures of bank risk and interest rates, suggesting that there was perhaps more of an expectation of regulatory bailout in earlier times, the relationship is more recently clearly evident in the data (cf. park and Peristiani). For developing countries too there is a growing body of evidence that bank risk is evident in interest rates: Barajas and Steiner (2000) provide evidence for Colombia; Davies and Robitaille (1997) for Chile; Martinez Peria and Schmukler (2001) for Argentina, Chile and Mexico; Mondschean and Opiela (1999) for Poland; Opiela (2001) for Thailand. Moreover, the extensive cross country study of Demirgűç-Kunt and Huizinga (2004) showed that in the absence of explicit deposit insurance, banks growing their portfolios rapidly had to pay an increasing cost for their funding.

The discovery by Martinez Peria and Schmukler that banks with a higher share of nonperforming loans (seen as a measure of risk) seem to lose share in the deposit market and to pay an interest rate premium even in the presence of deposit insurance, has been interpreted as implying that deposit insurance is more credible in some countries than in others (Chile more credible than Argentina<sup>4</sup> ). But it also alerts us to the need to hunt for alternative and supplementary reasons (other than risk) for differences between the interest rates paid by different banks.

> 3 The low money-to-GDP ratios (even conditional on inflation) in Sub-Saharan Africa, a low income region which has experienced above average incidence of depositor losses in banking crises, can be taken as indirect evidence of this.

> 4 They find that a bank’s ratio of insured to uninsured depositors is risk-sensitive in Chile, but not in Argentina, suggesting that the Argentine deposit insurance system lacked credibility.

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