Government Guarantees and Bank Vulnerability during a Crisis: Evidence from an Emerging Market
We analyze the performance of Indian banks during 2007–09 relative to their vulnerability to a crisis measured using pre-crisis data, in order to study the impact of government guarantees on bank performance during a crisis. Using bank branch-level regulatory data, we exploit geographic variation in the exposure to state-owned banks to show that vulnerable private sector bank branches in districts with greater exposure to state-owned banks 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 of loans. Our evidence suggests that access to stronger government guarantees during aggregate crises allows even vulnerable state-owned banks to access and extend credit cheaply despite their under-performance, and this renders private sector banks especially vulnerable to crises.
We thank Ilisa Goenka, Kavya Ravindranath, Rahul Singh Chauhan, and Akshat Vikram Singh for excellent research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research, CAFRAL, or the Reserve Banks of India.