Does regulatory forbearance matter for bank stability? Evidence from creditors' perspective

•Explore bank membership variation of a unique programme of corporate debt restructuring (CDR) in India to evaluate the effectiveness of regulatory intervention.•The regulatory forbearance (RF) in the guise of low provisioning on restructured loans increases stability of member banks.•The positive effect of RF however diminishes at the higher levels of market power.•Member banks with high market power tend to opt for more risky assets under the auspices of this programme.

Regulatory forbearance in times of corporate distress has been a common practice in many countries to achieve bank stability, particularly so in the absence of a unified bankruptcy code, yet very little is known in the context of emerging market economies. Exploiting variation of membership across banks in a corporate debt restructuring programme (CDR) sponsored by the central bank in India, this paper finds that the banks that made use of regulatory forbearance (RF) on the restructured corporate loans could increase their stability significantly due to the extension of low provisioning on restructured loans. However, the positive effect of RF diminishes at higher levels of market power, highlighting that member banks with higher market power tend to originate riskier assets (as reflected in their risk-weighted assets) under the auspices of this programme. Our results remain robust to different estimators (including propensity score matching), ownership structure, and alternative measures of bank stability.