Government Guarantees And Bank Vulnerability During The Financial Crisis: Evidence From An Emerging Market
Author(s) VIRAL V. ACHARYA AND NIRUPAMA KULKARNI

ABSTRACT

Updated on March 25, 2019

We analyze the performance of Indian banks during 2007–09 to study the impact of government guarantees on bank performance during a crisis. Vulnerable private-sector banks performed worse than safer private-sector banks; however, the opposite was true for state-owned banks. Exploiting geographic variation in exposure to public sector bank branches, we show that vulnerable private-sector bank branches in districts with greater exposure to public sector bank branches experienced deposit withdrawals and shortening of deposit maturity. In contrast, nearby vulnerable state-owned bank branches grew their deposit base and increased loan advances but with poorer ex-post performance. Our evidence suggests that lack of market discipline — in the form of access to stronger government guarantees and forbearance during an aggregate crisis — allows state-owned banks to access and extend credit cheaply despite their under-performance.


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