Do creditors punish weak banks? Evidence from Indian urban cooperative banks' failure

This study empirically assesses two critical hypotheses related to market discipline: (i) Do depositors penalize underperforming banks by withdrawing their deposits? and (ii) Do wellinformed peer banks reduce lending to weak banks? Based on the annual standalone balance sheet data of urban cooperative banks in India from 1990 to 2020, our findings suggest that: (i) the behaviour of savings and current depositors is not significantly affected by the bank risk; (ii) the risk-taking behaviour of the banks significantly influences term deposits; and (iii) other informed peer banks and financial institutions do respond to the riskiness of peer banks. Additionally, our research revealed a positive association between the size of assets and the deposit growth rate, indicating that depositors are responsive to the influence of the "too-bigto-fail"phenomenon. Moreover, depositors are sensitive to banks' non-interest expenditures. Banks with higher non-interest expenditures pay a higher interest rate to retain depositors, thus suggesting the presence of weak market discipline.