Government Guarantees and Bank Vulnerability during the Financial Crisis of 2007-09: Evidence from an Emerging Market 

Revise and resubmit to Journal of Financial Economics

We analyze performance of banks in India during 2007-09 to study the impact of government guarantees on bank vulnerability to a crisis. We find that vulnerable private-sector banks performed worse than safer banks; however, the opposite was true for state-owned banks. To explain this puzzling result we analyze deposit and lending growth. Vulnerable private-sector banks experienced deposit withdrawals and shortening of deposit maturity. In contrast, vulnerable state-owned banks grew their deposit base and increased loan advances, but at cheaper rates, and especially to politically important sectors. These results are consistent with greater market discipline on private-sector banks and lack thereof on state-owned banks which can access credit cheaply despite underperforming as they have access to stronger government guarantees and forbearance.

A Shotgun Solution to a Grave Problem: 

Resolving Zombie Lending with Collateral Reform

PRESENTATIONS: ABFER 2017 | CFIC 2017 | CICF 2019 | EEA 2019 (Withdrawn) | University of Oregon Summer Conference 2019  

We analyze performance of banks in India during 2007-09 to study the impact of government guarantees on bank vulnerability to a crisis. We find that vulnerable private-sector banks performed worse than safer banks; however, the opposite was true for state-owned banks. To explain this puzzling result we analyze deposit and lending growth. Vulnerable private-sector banks experienced deposit withdrawals and shortening of deposit maturity. In contrast, vulnerable state-owned banks grew their deposit base and increased loan advances, but at cheaper rates, and especially to politically important sectors. These results are consistent with greater market discipline on private-sector banks and lack thereof on state-owned banks which can access credit cheaply despite underperforming as they have access to stronger government guarantees and forbearance.

PRESENTATIONS: EFA 2016 | NEUDC 2018 | WFA 2018 | IFC 2018 | CUHK-RCFS 2019 

We analyze performance of banks in India during 2007-09 to study the impact of government guarantees on bank vulnerability to a crisis. We find that vulnerable private-sector banks performed worse than safer banks; however, the opposite was true for state-owned banks. To explain this puzzling result we analyze deposit and lending growth. Vulnerable private-sector banks experienced deposit withdrawals and shortening of deposit maturity. In contrast, vulnerable state-owned banks grew their deposit base and increased loan advances, but at cheaper rates, and especially to politically important sectors. These results are consistent with greater market discipline on private-sector banks and lack thereof on state-owned banks which can access credit cheaply despite underperforming as they have access to stronger government guarantees and forbearance.

PRESENTATIONS: NBER SI 2015 | Becker Friedman Institute Conference 2016 | EFA 2017  

We analyze performance of banks in India during 2007-09 to study the impact of government guarantees on bank vulnerability to a crisis. We find that vulnerable private-sector banks performed worse than safer banks; however, the opposite was true for state-owned banks. To explain this puzzling result we analyze deposit and lending growth. Vulnerable private-sector banks experienced deposit withdrawals and shortening of deposit maturity. In contrast, vulnerable state-owned banks grew their deposit base and increased loan advances, but at cheaper rates, and especially to politically important sectors. These results are consistent with greater market discipline on private-sector banks and lack thereof on state-owned banks which can access credit cheaply despite underperforming as they have access to stronger government guarantees and forbearance.

PRESENTATIONS: Norges Bank Conference (Oslo) 2019 | FDIC seminar series 2019 | Columbia 2019 

We analyze performance of banks in India during 2007-09 to study the impact of government guarantees on bank vulnerability to a crisis. We find that vulnerable private-sector banks performed worse than safer banks; however, the opposite was true for state-owned banks. To explain this puzzling result we analyze deposit and lending growth. Vulnerable private-sector banks experienced deposit withdrawals and shortening of deposit maturity. In contrast, vulnerable state-owned banks grew their deposit base and increased loan advances, but at cheaper rates, and especially to politically important sectors. These results are consistent with greater market discipline on private-sector banks and lack thereof on state-owned banks which can access credit cheaply despite underperforming as they have access to stronger government guarantees and forbearance.

PRESENTATIONS: IIM Calcutta-NYU Stern India Research Conference 2019 | NSE-NYU conference 2019 | IMF 2019 | Delhi Winter School 2019 | ISI 2019 

The secular rise of "zombie" borrowers, insolvent firms sustained by continued extension of credit by complicit banks, has been a source of concern for mature and emerging economies alike. Using supervisory data on the universe of large bank-borrower relationships in India, we introduce a novel method for identifying zombies. Although there was widespread non-disclosure of zombies in India in 2014, the beginning of the sample period, there have been major improvements since. We examine changes in zombie reporting around two key policy changes: an overhaul of the bankruptcy code and a regulatory intervention removing lender discretion in bad loan recognition. Increases in reporting were modest after the bankruptcy reform but there was a sizable jump in the recognition of zombies after the regulatory intervention. Post-intervention results show that lending has been reallocated to large, healthy borrowers. However, under-reporting still exists, particularly among public-sector banks. Overall, our results indicate that regulatory action might be necessary, above and beyond bankruptcy reform, to target zombie lending

PRESENTATIONS: VAT conference 2019 organized by University of Michigan/Columbia/World Bank | NEUDC 2019 | Eighth Delhi Macroeconomics Workshop 2019

This paper studies whether the elimination of tax distortions on capital goods
through an investment tax credit induces financially constrained firms to expand their

stock of plant and machinery. We exploit a unique setting in India involving the re-
placement of the retail sales tax with a value-added tax (VAT). The VAT structure

permitted firms to reduce their final VAT liability with VAT paid on the purchase of
capital inputs, eliminating in the process the cascading effect of sales taxes levied at
multiple points in the production chain, and lowering the cost of plant and machinery
for firms. Using the differential timing in VAT roll-out across Indian states as a source
of exogenous variation, the paper identifies the causal impact of this reduction in the
cost of capital on firms’ plant and machinery. The results show that firms increase their
stock of plant and machinery in response to the investment tax credit offered through
the VAT framework with the effects being driven by firms operating in industries with a
high dependence on external finance, and firms which have a higher likelihood of being financially constrained based on observable characteristics. The results also document an increase in firm productivity post VAT adoption by states, but limited to firms operating in industries with a high dependence on external finance and firms most likely to be financially constrained based on observable characteristics. Collectively, the results suggest that financially constrained firms respond to the VAT-induced reduction in the cost of capital to expand their plant and machinery and adopt improved production technologies.