Impact of Improved Creditorss Rights on Bank Competition and Credit Allocation: An Empirical Study

Abstract

This study empirically investigates the impact of SRFAESI Act on debt financing by foreign banks in India. Two-way error component model (fixed effect panel) was used for this within-country assessment. Taking advantage of a policy event (Securitization and Reconstruction of Financial Asset and Enforcement of Security Interests in India (SRFAESI), Act, 2002, which improved the creditors’ rights (banks) in India ; we empirically examined its effect on firms in India. Specifically, we analyse if the entry of a foreign bank in a district, post SRFAESI has improved credit access for the firms. SRFAESI gives the banks a right to liquidate collateral in case of a default, therefore it should encourage lending. The impact is expected to be more in the districts were the foreign bank has entered for the first time compared to other locations where a foreign bank already existed. Theoretical literature suggests that enforcement of law should encourage more lending. Also, prior studies on credit allocation argue that use of collateral reduces credit rationing. Hence, combining these two strands of literature we can provide empirical evidence of the impact of stronger creditor’s rights on reducing information asymmetry. Amount of bank borrowings pre- and post-event; after controlling for firm level factors, was the model used for the analysis. The estimates indicate that High tangible firms received larger share of bank loans, but that on average, younger firms (