Lender-Borrower bond improves credit flow

MUMBAI: During the nineties, crony capitalism was blamed for the Asian financial crisis. It essentially implies that the success of one’s business depends on relationships between business people and government officials, or in other words, extracting favours in different forms to further one’s interest.

The popular notion in India is that when it comes to banking loans are seldom extended on viability or merit, but often out of ‘personal’ considerations, resulting in loans going bad. But a new research “Cultural Proximity and Loan Outcomes” conducted by Raymond Fisman, Daniel Paravisini, Vikrant Vig of the London Business School has found that cultural proximity between lenders and borrowers improves efficiency of credit allocation. The authors found a strong evidence of efficient credit allocation when there are shared beliefs between lenders and borrowers.

The authors have even identified in-group (where lenders and borrowers are from the same caste or community) preferential treatment using religion and caste as data of officers and borrowers from a bank in India. Their analysis shows that having an ingroup officer means there is better access to credit even as collateral requirements are lower. The transfer policy of public sector banks in India, which stipulates transfer of officers and mandatory posting in rural and semi-urban areas, seems to be working well when it comes to loan decisions.

The results imply that cultural proximity mitigates informational issues that adversely affect lending, the authors say. Loans made to in-group borrowers have a better repayment record: they are nearly 15% less likely to be late in loan payments. This is found to be the case even after the in-group officer is replaced by someone from the outside community. The study also reveals that cultural proximity influences officers to increase credit to some borrowers more than others within their own groups. These findings suggest that cultural proximity mitigates problems of asymmetric information in lending and improves the allocation of credit across borrowers with heterogeneous repayment prospects. The study also admits to limitations. There are challenges in identifying the extent of preferential in-group treatment: it needs information on the loan officer and the borrowers. Most studies have relied on the religion or race of only one party.