Can Financial Markets Predict Banking Distress? Evidence from India

Reserve Bank of India Occasional Papers Vol. 40, No. 2: 2019

26 Pages Posted: 7 Jun 2021 Last revised: 16 Jun 2021

See all articles by Snehal Herwadkar

Snehal Herwadkar

Reserve Bank of India, Monetary Policy Department

Bhanu Pratap

Reserve Bank of India

Date Written: 2019

Abstract

In this paper, we test whether the efficient market hypothesis works in the context of Indian banking sector. In particular, using a panel dataset of 39 publicly listed banks in India for 2009–2017, we test whether equity markets provide any lead information about stress in the banking system before quarterly data becomes available to the supervisors. We find that markets are able to price-in the banking stress concurrently but not much in advance. As the supervisory data are available with a lag, there is some merit in incorporating market-based information to track banking distress. Use of a machine learning technique to reaffirm the results is a novelty of this paper. Interestingly, our findings suggest that markets are relatively less efficient in the case of public sector banks vis-à-vis private sector banks.

Keywords: banking sector, banking distress, equity markets, financial stability

JEL Classification: C14, C33, C51, G21, G14

Suggested Citation

Herwadkar, Snehal and Pratap, Bhanu, Can Financial Markets Predict Banking Distress? Evidence from India (2019). Reserve Bank of India Occasional Papers Vol. 40, No. 2: 2019, Available at SSRN: https://ssrn.com/abstract=3852930

Snehal Herwadkar

Reserve Bank of India, Monetary Policy Department ( email )

Development Research Group,
8th floor, Central Office Building
Mumbai, Maharashtra 400001
India
91-022-22661602 ext 2528 (Phone)
91-022-22610769 (Fax)

Bhanu Pratap (Contact Author)

Reserve Bank of India ( email )

Shahid Bhagat Singh Road
Mumbai
Mumbai, Maharashtra 400051
India

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