Let a small bank fail: Implicit nonguarantee and financial contagion

Liyuan Liu, Xianshuang Wang and Zhen Zhou

No 11/2024, BOFIT Discussion Papers from Bank of Finland Institute for Emerging Economies (BOFIT)

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.

Keywords: Implicit guarantee; Bailout; Contagion; Price efficiency; Credit allocation; TBTF (search for similar items in EconPapers)
JEL-codes: G14 G21 G28 H81 (search for similar items in EconPapers)
Date: 2024
New Economics Papers: this item is included in nep-ban, nep-cba, nep-fdg and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bofitp:305281

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