Abstract: The establishment of the deposit insurance system has imperceptibly weakened the incentive for depositors’ self-discipline, resulting in the absence of market discipline for banks. In this case, what can constrain banks in place of the market? This paper empirically examines the changes in banks’ internal risk after the implementation of the deposit insurance system by constructing a system of association equations in relation to the risks among depositors, non-deposit creditors and shareholders using data of 185 commercial banks from 2011 to 2019. The findings are as follows. (1) Shareholders’ risk appetite increases after the implementation of the deposit insurance system; depositors are exposed to higher risks when market constraints on them are absent; non-deposit creditors are exposed to lower risk when they play the role of market constraints instead. Shareholder risks are no longer shared mutually by depositors and non-deposit creditors, but predominantly by depositors. This trend is particularly pronounced for small and medium-sized banks and remains the same under the feedback mechanism for overall bank risks. (2) Given that depositors have a motive for earning, shareholders have a motive for asset share and non-deposit creditors have a motive for earning, asset share and overall risk, the 3 subjects at the micro-level of bank adjust their risk-taking through their respective motive. (3) Strengthening external regulation affects market constraints on banks in such a manner as to alleviate the outcome of missing depositor constraints and crowd out market constraints on non-deposit creditors. Therefore, a key to designing the deposit insurance system is to keep in line with the regulatory policy objectives and guide beneficiaries at the micro-level of bank to follow prudent banking practice.

Key words: deposit insurance system, market constraints, risk allocation, risk transfer, non deposit creditors