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Let a small bank fail: Implicit nonguarantee and financial contagion

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  • Liu, Liyuan
  • Wang, Xianshuang
  • Zhou, Zhen

Abstract

This paper examines the consequences of Chinese regulators deviating from a long-standing full bailout policy in addressing the distress of a city-level commercial bank. This policy shift led to a persistent widening of credit spreads and a significant decline in funding ratios for negotiable certificates of deposit issued by small banks relative to large ones. Our empirical analysis reveals a novel contagion mechanism driven by reduced confidence in future bailouts (implicit non-guarantee), contributing to the subsequent collapse of other small banks. However, in the longer term, this policy shift improved price efficiency, credit allocation, and discouraged risk-taking among small banks.

Suggested Citation

  • Liu, Liyuan & Wang, Xianshuang & Zhou, Zhen, 2024. "Let a small bank fail: Implicit nonguarantee and financial contagion," BOFIT Discussion Papers 11/2024, Bank of Finland Institute for Emerging Economies (BOFIT).
    • Handle: RePEc:zbw:bofitp:305281
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    References listed on IDEAS

    as
    1. Amir Sufi, 2009. "Bank Lines of Credit in Corporate Finance: An Empirical Analysis," The Review of Financial Studies, Society for Financial Studies, vol. 22(3), pages 1057-1088.
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    Keywords

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    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • H81 - Public Economics - - Miscellaneous Issues - - - Governmental Loans; Loan Guarantees; Credits; Grants; Bailouts

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