If the financial crisis had a silver lining, India?s public sector banks (PSBs) doubtlessly sparkled in it. The crisis helped them strengthen their competitive position vis-?-vis their private sector rivals, channelled large capital infusions from the exchequer without a murmur and burnished their image as the keepers of the nation?s wealth. During 2008-09, PSBs grew their deposits by over 24%, more than a percentage point higher than in the previous year. Private sector bank deposits grew by a mere 8%, down from 20% the previous year. Credit grew at over 20% for PSBs, only a shade lower than the 22.5% in the previous year. For private banks, it was less than 11%, down from almost 20%. The 54% fall in the SBI share value was far more palatable than the 73% decline in ICICI Bank?s. At the same time, the government infused over R3,000 crore in tier-1 capital for four PSBs. Now that the crisis is largely in the rear-view mirror, it is time to ask what was the secret of their success?were they really running a safer ship or was it just government guarantee that assured their relatively better performance?

The contribution of conservative RBI policies and supervision and the underdevelopment of credit derivative markets to the health of India?s banking sector is not in question here. The Capital to Risk-weighted Assets Ratio (CRAR) stood at a very decent 13%, well above the regulatory minimum of 9%, which itself was a percentage point higher than the Basel minimum norm. Worldwide CRAR ranged from 8.2% to 17.7%. The provision for NPAs stood at over 52%, with the global range being 25% to 184%. The sector was also profitable with a 1% Return on Assets, comparable to the world figures and far higher than in most developed countries.

But these apply to banks across the public-private divide. The question is, among the different bank categories in India, did the strength of PSBs lie in their efficiency and conservatism in operations or simply in their government guarantee. The credit default swap spreads for SBI and ICICI Bank tell an interesting story. Until about January 2008, both hovered around the same level. And then suddenly ICICI Bank started looking much more riskier than SBI. What was the source of this difference?operational conservatism or access to government funds?

It is not a simple question to answer, but a recent paper by Viral Acharya, Anukaran Agarwal and Nirupama Kulkarni* tries just that. They compare the risk levels of several Indian banks and NBFCs?public and private?just before the crisis by looking at their Marginal Expected Shortfall (MES) or ?tail beta??the sensitivity of a bank?s stock return to an index return on the 5% worst market days. Next, they look at their actual performance during the crisis period and see if it is in line with what the MES would predict.

The relationship between the MES and crisis performance seems to be very different for private and public sector banks. The riskier private banks and NBFCs expectedly fared worse when the crisis hit, but for the PSBs, there was no such pattern. As a group, the private sector banks had an average MES nearly a whole percentage point lower than the PSBs. Both SBI and ICICI Bank, their respective leaders, had comparable MES at 5% going into the crisis.

And yet, as a group, the private banks suffered a fall that was a full 20% bigger than for the PSBs.

Within categories, the difference is even starker in the deposit growth. Here, while the private banks show a statistically negative relationship between MES and crisis-period returns, PSBs actually show a statistically significant positive association?the more risky the PSB going into the crisis, the greater is its deposit growth. Normal behaviour was evidently suspended.

If markets rewarded risky banks during a downturn, something other than conventional risk had to be the deciding factor. The insurance of a friendly government is the obvious answer. For the riskiest PSBs, the crisis may have actually enhanced their chances of a capital injection.

The issue raised in the paper is a critical one, not just for a more accurate reading of history but in driving banking policy going forward. Thriving on the back of government guarantee is not unique to India?just look at Fannie Mae and Freddie Mac in the US?but one should not confuse it with efficiency or better risk management. This paper may not be the final word in the public-private debate, but for now, its conclusions seem very, very convincing.

* State Ownership and Systemic Risk: Evidence from the Indian Financial Sector during 2007-09, Working Paper, Stern School of Business, New York University

?The author teaches finance at the Indian School of Business, Hyderabad