The impact of government guarantees on banks' wholesale funding costs and lending behavior: Evidence from a natural experiment

This study compares the effects of the introduction and subsequent removal of a unique government Wholesale Funding Guarantee Scheme (WGS) in Australia on the funding costs and loan growth of authorised deposit-taking institutions (ADIs). Our identification strategy exploits the voluntary adoption of the WGS by ADIs using a difference-in-differences estimation approach. We find strong causal evidence to indicate that the government guarantee helped large ADIs to reduce their funding costs relatively more than for smaller ADIs. Furthermore, large ADIs continued to benefit from the WGS beyond the official removal of the government guarantee due to market perceptions of continued implicit government support for the too-big-to-fail banks. We also find that the guarantee encouraged large banks to shift their loan portfolios into housing loans thereby reducing their riskiness. Further tests using guaranteed and non-guaranteed bonds issued by ADIs show that the largest banks experienced a net reduction of 6.2 bps from adopting the government guarantee.