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

Using an unexpected government regulation that restricted the ability of microfinance institutions to recover loans in one Indian state, I examine whether this intervention affected bank loan performance. The bank loan delinquency rate significantly increased as a result. In response, the ex post bank credit supply declined by more than half. For identification, I 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. I conclude that political interventions in credit markets could have significant spillover effects.