Government guarantees and dynamic debt runs

Abstract

This study quantifies the impact of public guarantees on the stability of bank wholesale funding. We study the Chinese market for negotiable certificates of deposit (NCDs), focusing on the period surrounding the first bank failure in two decades in China, which struck the market belief of government guarantees on wholesale funding debts. We document an increase in NCD spreads and issuance failures, especially among poorly performing banks. Using a model of dynamic debt runs, we estimate that the implicit guarantee fell from around 16% to 0% because of the default event. The estimated model implies that a higher guarantee increases creditors’ willingness to roll over debt even at lower values of the bank’s fundamentals, reducing runs on potentially solvent banks. At the same time, a higher guarantee hinders the pricing of risk.

Keywords: wholesale funding fragility, bank runs, central bank intervention, implicit guarantee

JEL Classification: G14, G21, G15, E44