The Dark Side of Cultural Proximity In Credit Markets

Using the Indian caste system and the group loan structure, where members screen and monitor each other, we ask whether social ties impede or improve loan performance. We find that borrowers belonging to caste homogeneous groups default more and their inferior loan performance is not explained by occupational similarity within castes. Our results show that the possibility of mass strategic default and also contagion arising due to social connections, independent of common occupational shocks, undo informational and relationship advantage of caste homogeneous groups. Interestingly, in sub-samples where strategic default and caste based contagion are less likely, caste homogeneous groups actually default less, in line with Fisman et al. (2017). We conclude that the overall impact of social connections on credit markets depends on the relative influence of informational efficiency and better enforcement capacity on one side and possibility of coordinated strategic default and contagion on the other.