When consumers barely trust institutions, banking fines might lead people to withdraw their money.
Banks need depositors’ loyalty. Only with a stable, predictable deposit base can banks confidently make loans and keep the wheels of finance turning.
Regulators do their part to make sure banks are worthy of that trust. At times, this can mean levying uncharacteristically large penalties, such as the ones that India’s regulatory agency imposed on a handful of commercial banks in 2013. Do such actions give depositors more faith in the financial system? Or do they shake customer confidence and cause them to pull their deposits from all banks?
The answer is the latter, at least when trust in public institutions is already low, as it usually is in developing countries, according to Abhiman Das of the Indian Institute of Management Ahmedabad, Tanmoy Majilla of Plaksha University, and Chicago Booth’s Rimmy E. Tomy. The researchers argue that trust is crucial to the effects of penalties, as it points to whether depositors see a regulator as having correctly identified a problem or as being the source of larger systemic issues.
The researchers took advantage of a unique regulatory event in India in 2013 following an investigation into three major private-sector banks—Axis Bank, HDFC Bank, and ICICI bank—by the news website Cobrapost. The outlet published videos of top bank executives instructing an undercover journalist on money laundering. The ensuing public uproar prompted the Reserve Bank of India to investigate all commercial banks. Although enforcement actions against commercial banks in India are infrequent, the RBI eventually imposed significant penalties on dozens of banks that were found to be in violation of rules.
To see the effect this had on the financial system, the researchers sourced branch-level deposit and credit information from the RBI’s Basic Statistical Returns database, as well as data on monetary penalties issued by the RBI against individuals and banks from watchoutinvestors.com. They also obtained data on demographics, geographic characteristics, and trust.
To delineate the role of trust in institutions, the researchers focused on the deposits of nearby unpenalized banks. Depositors located near offending banks’ branches would likely have known about the penalties—through word of mouth, neighborhood social networks, or neighbors’ actions. If they had reallocated capital within the banking system, they would have likely moved funds to another bank branch nearby. On the other hand, if depositors had removed their funds from the system altogether, the neighboring branches should have also seen deposits fall, the researchers conjectured.
The researchers were able to tie the penalties to deposit behavior thanks to the quasi-random nature of bank-branch locations in India, where openings are driven not just by economic conditions but also by the policy goal of financial inclusion.
By Francine McKenna/Courtesy CBR Accounting
