Paper Banking on Trust: Supervisory Penalties and Depositors’ Actions
We explore the role of trust in banks in influencing depositors’ reactions to supervisory penalties. We utilize branch-level data on the deposits of commercial banks in India, where institutional trust is low yet there is significant regional variation in trust. Our setting exploits the 2013 Cobrapost exposé, a widely publicized undercover investigation that revealed money laundering and internal control failures at major Indian banks, prompting the bank regulator to impose unprecedented penalties on several banks. Our identification strategy focuses on the deposits of neighboring nonoffending banks, which are unlikely to face increased solvency risk, and exploits the quasi-random nature of bank branch location. We find that news of supervisory penalties leads depositors to withdraw funds from offending and neighboring nonoffending banks, consistent with a loss of generalized trust in the banking system. Relative to regions with higher baseline trust in banks, such withdrawals are more pronounced in regions with lower trust. We explore the determinants of such trust and find it strongly associated with information access and the quality of local services. Credit access and economic activity also decline in regions that experience deposit withdrawals.
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- 2023
- Fama - Banking & Financial Institutions