Contagious Effects of a Political Intervention in Debt Contracts: Evidence Using Loan-Level Data

Using an unexpected government regulation that restricted the ability of micro-finance institutions to recover loans in one Indian state, we examine whether this intervention impacted bank loan performance. The bank loan delinquency rate increased significantly as a result. In response, the ex-post bank credit supply declined by more than half. For identification, we compare loans from branches located in regions subject to this intervention with loans from nearby branches of the same bank located in regions not subject to the intervention. We conclude that political interventions in credit markets could have significant spillover effects.