Implicit guarantees and bank stability: Evidence from a quasi-natural experiment

Do parent bank implicit guarantees enhance or diminish the stability of foreign subsidiaries? Using a quasi-natural experiment in the form of a regulatory intervention which removed parent banks' option to provide financial support to affiliated foreign subsidiaries, we find a substantial increase in the overall default risk of foreign subsidiaries. Less stringent private and supervisory oversight in host countries exacerbates the adverse impacts on risk. Overall, the results align with the notion that a loss in implicit guarantees implies a decline in reputational capital and franchise value. Beyond financial stability, the intervention likely has economic implications. Foreign subsidiaries increase lending and deposit funding, particularly those with stronger initial capitalization. These patterns are consistent with risk-compensating behavior where subsidiaries, following the loss of parental guarantees, expand balance sheets to sustain funding and market presence. Our findings inform ongoing policy debates regarding the merits of implicit guarantees for bank stability.

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Publication Details

Journal
Journal of International Economics
Published
2025-04-19
DOI
https://doi.org/10.1016/j.jinteco.2025.104094
Primary Topic
Banking stability, regulation, efficiency
Type
article
Field-Weighted Citation Impact
0.00
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article

Implicit guarantees and bank stability: Evidence from a quasi-natural experiment

Lechedzani Kgari, Anna L. Sobiech, Linh Nguyen, John O. S. Wilson
Journal of International Economics
Banking stability, regulation, efficiency
article

Implicit guarantees and bank stability: Evidence from a quasi-natural experiment

Lechedzani Kgari, Anna L. Sobiech, Linh Nguyen, John O. S. Wilson
article en

Abstract

Do parent bank implicit guarantees enhance or diminish the stability of foreign subsidiaries? Using a quasi-natural experiment in the form of a regulatory intervention which removed parent banks' option to provide financial support to affiliated foreign subsidiaries, we find a substantial increase in the overall default risk of foreign subsidiaries. Less stringent private and supervisory oversight in host countries exacerbates the adverse impacts on risk. Overall, the results align with the notion that a loss in implicit guarantees implies a decline in reputational capital and franchise value. Beyond financial stability, the intervention likely has economic implications. Foreign subsidiaries increase lending and deposit funding, particularly those with stronger initial capitalization. These patterns are consistent with risk-compensating behavior where subsidiaries, following the loss of parental guarantees, expand balance sheets to sustain funding and market presence. Our findings inform ongoing policy debates regarding the merits of implicit guarantees for bank stability.

Journal of International EconomicsVol. 155
University of Botswana (BW), University of St Andrews (GB), University of Cologne (DE)
Openalex Percentile: Top 89%
Banking stability, regulation, efficiency
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