Government Guarantees And Financial Stability:Empirical Evidence From The Silver Crisis

Commercial banks play a pivotal role in the financial system,and the Great Depression of the 1930s illustrated the potentially catastrophic consequences of a banking crisis.Bank runs caused bank deposits to fall,many banks were afraid to make new loans,and businesses had difficulty in investment and financing activities,ultimately causing the most severe global recession in modern history.Therefore,maintaining the stability of the banking sector is of great importance to economic development.In recent years,how to guard the bottom line against systemic risks has become an important issue for the Communist Party of China and the government.In April 2022,the People’s Bank of China released the Financial Stability Law(Draft for Public Comments),which outlines the goal of maintaining financial stability as ensuring that financial institutions,financial markets and financial infrastructure continue to perform critical functions.For a financial system like China’s,which is dominated by indirect financing,the focus of safeguarding the continued critical functions of financial institutions is to ensure the smooth operation of the banking system,especially the normal functioning of the banking system in times of financial crisis.At the same time,the stable operation of the financial system cannot be maintained without macro-control by the "active government".It is also important for the government to implement strong measures to provide market players with stable policy expectations and prevent the spread of panic in times of financial crisis.In the 1930s,China experienced a "silver crisis" caused by the exogenous shock of the U.S.Silver Purchase Act,but the Chinese banking system maintained relatively stable operating conditions,unlike the massive bank failures in the United States during the Great Depression.During the crisis,the Nanjing Nationalist Government released signals of government guarantees,which provided an ideal natural experiment to verify the role of government guarantees in maintaining the stability of the banking system.In view of this,this research empirically examines the role of government guarantees in maintaining financial stability during the crisis from the perspective of depositors,using the "silver crisis" as an exogenous shock,and further analyzes the impact of the banks’ own operating conditions on the research findings.In addition,we further explore the differences in lending,asset growth,profitability,and riskiness between government-guaranteed and non-government-guaranteed banks during and after the crisis,as well as the effects of the guarantee tiers,institutional environment,and banks’ business strategies.The main findings of this research are as follows:first,government guarantees significantly reduce the probability of bank runs during crises,and banks that are guaranteed by the government have more deposit inflows.This reallocation of deposits across banks does not stem from the banks’ own operating conditions,but from the effect of government guarantees.Second,during the crisis,government-guaranteed banks placed more credit and had higher asset growth rates,which contributed to the recovery,but this came at the cost of taking greater business risks,and this performance of government-guaranteed banks during the crisis was not sustainable.Third,banks guaranteed by the central government had more deposit inflows relative to banks guaranteed by local governments,and the financial stability effect of government guarantees was greater for banks with more small and medium-sized depositors and located in regions with a better institutional environment.Based on the above findings,this research draws the following policy insights:first,government intervention helps stabilize market confidence in times of financial crisis.In response to a liquidity crisis,the government’s release of a guarantee can prevent a massive outflow of deposits from the financial system,causing a collapse of the entire financial system.Second,it should prevent financial institutions from becoming too closely linked and too big to fail,and improve the transparency of information on financial institutions so that supervisory authorities can distinguish whether the institutions in need of bailout are insolvent or illiquid.Third,the government should play a better role in "preventing risks and stabilizing growth",insist on the combination of effective market and active government,and stabilize the policy expectations of market players.The main innovation of this research is that,first,we use the historical silver crisis in China to verify the importance of government intervention in times of crisis at the micro level,providing historical empirical evidence and a new perspective for research on how to deal with the risk of deposit outflows and maintain financial stability.Second,this research demonstrates the role of government guarantees in maintaining financial stability by introducing an interaction term between key bank operating-level variables and the silver crisis to exclude as much as possible the influence of banks’ own operating conditions,and by controlling the amount of bank exchange certificates issued to reduce the disturbance of currency issuance by issuing banks on the number of book deposits,which overcomes the endogeneity bias to a certain extent and effectively identifies the causal relationship.Third,this research further explores the differences between government-guaranteed and non-government-guaranteed banks in terms of lending,profitability,and risk during and after the crisis,and enriches the ways in which government guarantees maintain financial stability by analyzing the heterogeneity of different guarantee tiers,different institutional environments,and different business layouts of banks.