Do repeated government infusions help financial stability? Evidence from an emerging market

Madhu Kalimipalli, Olaleye Morohunfolu and Shankar Ramachandran

Journal of Financial Stability, 2024, vol. 75, issue C

Abstract: While government led bank capital infusions in US and other developed markets have been usually contingent an external shock or crisis episode, India presents a unique setting where significant capital infusions happen annually to stabilize the weak balance sheets of undercapitalized government owned public sector banks. Such “repeated” capital infusions can either better engender financial stability, given the timely government interventions; or create instability arising from possible moral hazard concerns. "Do such repeated government capital infusions lower banks’ financial risks and improve financial stability?” We shed light on the question through the lens of capital infusions in the Indian market. Based on the exhaustive sample of government capital infusions into public sector banks for the period 2008–18, we find robust evidence that capital infusions are associated with economically significant higher default, capital shortfall and network risks post-infusion, signaling a moral hazard problem, where treated banks may assume more risky investments.

Keywords: government capital infusions; financial stability; systemic risk; default risk; emerging markets (search for similar items in EconPapers)
JEL-codes: G10 G14 G15 G30 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:75:y:2024:i:c:s1572308924001190

DOI: 10.1016/j.jfs.2024.101334

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