State Ownership and Systemic Risk: Evidence from the Indian Financial Sector During 2007-09

Project Active from to Firms and Entrepreneurship

We analyze the performance of banks in India during the period 2007-09 in order to study the impact of ownership structure on bank vulnerability to a crisis. We find that in the private sector, vulnerable private-sector banks -- based on ex-ante measures of exposure to a crisis -- performed worse than safer banks; however, the opposite was true for state-owned banks. We explain this puzzling result by analyzing the behavior of deposit and lending growth of banks. The vulnerable private-sector banks experienced deposit withdrawals and shortening of deposit maturity relative to other private-sector banks. In contrast, vulnerable state-owned banks relatively grew their deposit base, more so in term deposits, and increased their loan advances, at cheaper rates, and especially to public sector firms. These results are consistent with greater market discipline on private-sector banks and lack thereof on state-owned banks which are able to access credit cheaply even after underperformance as they have access to stronger government guarantees and forbearance.