Updated on March 25, 2019

We analyze the performance of Indian banks during 2007–09 to study the impact of government guarantees on bank performance during a crisis. Vulnerable private-sector banks performed worse than safer private-sector banks; however, the opposite was true for state-owned banks. Exploiting geographic variation in exposure to public sector bank branches, we show that vulnerable private-sector bank branches in districts with greater exposure to public sector bank branches experienced deposit withdrawals and shortening of deposit maturity. In contrast, nearby vulnerable state-owned bank branches grew their deposit base and increased loan advances but with poorer ex-post performance. Our evidence suggests that lack of market discipline — in the form of access to stronger government guarantees and forbearance during an aggregate crisis — allows state-owned banks to access and extend credit cheaply despite their under-performance.