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A recent research paper has studied how government support quietly lowers the financial risk for some of India’s biggest banks. The study focuses on six major Indian banks and tries to measure the default risk that is indirectly ‘insured’ by the government. These 6 banks are: Axis Bank, HDFC Bank, ICICI Bank, Kotak Mahindra Bank, Bank of Baroda (BOB) and the State Bank of India (SBI).
What Is Implicit Government Guarantee?
The term implicit government guarantee means that even if it’s not officially promised, investors believe the government will rescue big banks if they are in trouble. This belief reduces the risk for those lending money to the banks, especially in tough times.
Two Ways to Measure Bank Risk
The researchers used two different methods to estimate the chance that a bank might fail (default):
- Equity Market-Based Risk
- This method uses bank share prices and assumes no government help in case of crisis.
- It reflects what equity investors think the risk is if banks are on their own.
- Credit Default Swap (CDS)-Based Risk
- CDS are like insurance for loans — they pay out if a bank defaults on its debt.
- The CDS-based risk includes the chance that the government might not step in to help the bank repay its debts.
- This measure is usually lower than equity-based risk due to belief in government backing.
How the Implicit Subsidy Is Calculated
The difference between these two risk estimates is used to figure out how much support the market thinks the government is silently providing to these banks. This hidden help is referred to as the implicit subsidy.
Subsidies Have Reduced, But Still Exist
The study found that:
- This implicit support was very high during the Global Financial Crisis and the Covid-19 pandemic.
- Over time, the subsidies have decreased, but they are still significant.
- This shows that investors still believe the government will not let major banks fail, even if it’s not stated officially.
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