Effects of government capital injection on bank and bank-dependent borrower

We examine the impacts on bank interest margin, bank default risk, and bank-dependent borrower default risk from changes in the bailout program of government capital injections. This paper focuses on the capped credit risk, the risk of default related to borrower health states. We show that government capital injection helps to reduce default risk for the bank, but indirectly increases the default risk for the borrowing firm. Government capital injection is more likely to produce greater safety for the bank when the borrowing firm is in a distressed situation (e.g., a high-risk and low-return one). The capital effect on bank safety is underestimated when the capped credit risk is ignored. We conclude that a government capital injection program stabilizes the bank, but deteriorates the borrowing firm.