Responsible lending: credit may precipitate firm failure in volatile macroeconomic environments

Abstract

This article models firm survival in Kenyan manufacturing with a particular emphasis on the effect of credit on firm resilience. The article explores how firms coped with the challenging economic environment that prevailed in the 1990s particularly the effect of the dramatic increase in interest rates. The key finding is that the burden of loans precipitated firm failure in the 1990s but overdrafts did not seem to have had a significant impact on firm failure. Furthermore, older firms appear to have resisted better than younger ones, but there is no evidence that large firms had higher survival rates. These results are robust to different specifications, namely probit models, Cox proportional hazard models and exponential, Gompertz and Weibull parametric hazard models. The main contribution of the article is to highlight the role of responsible lending as credit may lead some categories of firms to failure in shock-prone developing economies. The study also shows that the key factors explaining firm survival in developed economies, namely size and age, are not necessarily the most relevant determinants of firm survival in developing economies. Methodologically, this article is one of the few that have applied hazard analysis to firms in developing economies.