Title: The Political Economy of Bank Lending: Evidence from an Emerging Market

Speaker: Assistant Professor Jian Zhang, Hong Kong Baptist University

Time: October 19th, 2016 13:30–15:00 

Venue: Conference Room 106B, Zhonghui Building (College of Economics, JNU)

Abstract:

This study investigates the existence of political distortions in bank lending, using a comprehensive loan-level dataset of the universe of commercial loans in Mexico from 2001 to 2012. Identification relies on changes in the state of origin of a senate committee chair as a source of exogenous variation in firms’ political relationship. We find that banks offer favourable loan terms to politically connected private firms (i.e., firms from states where a senator serves as chair of a committee) with larger loan quantities and lower loan spreads. Furthermore, these loans exhibit higher default rates. To isolate the bank supply channel, we include a rich set of fixed effects with various specifications as well as time-variant state controls to account for economic activity and several forms of state-level public spending. The favourable lending increases with the strength of a firm’s political connection (such as firms from industries in direct purview of the chair’s committee), varies gradually along the political cycle and tends to be offered by large banks with a high ex-ante share of commercial lending to government-backed firms. Consistent with the quid pro quo hypothesis, we find that the banks that extend loans to politically connected private firms, also extend more government-backed loans at higher interest rates and with better credit quality. We also show that greater credit supply to politically connected firms leads to a large and significant increase in firm-level employment and assets. We provide estimates of the total social cost of political lending and net revenue for banks that are engaged in the rent provision activity. Finally, we perform a series of robustness tests to rule out alternative mechanisms and explanations.