Bad loan build-up in India: A reflection of soft budget constraints
Abstract
This paper analyses the non-performing assets (NPA) crisis in the Indian banking system from the perspective of soft budget constraints. Using a panel dataset of 105 publicly listed firms, it explores the relationship between NPAs and bank lending behaviour, particularly examining credit rationing regarding firm size and risk level. The findings indicate that Indian banks favour large firms over smaller ones, while credit rationing is not adequately aligned with borrower riskiness. However, the Asset Quality Review (AQR) by the Reserve Bank of India and the introduction of the Insolvency and Bankruptcy Code (IBC) seem to have enforced risk-based lending to some extent. These results shed light on the systemic issues that drive NPAs, linking them to governance weaknesses and the prevalence of soft budget constraints.
Full text article
References
Alnabulsi, K., Kozarević, E., & Hakimi, A. (2023). Non-performing loans as a driver of banking distress: A systematic literature review. Commodities, 2(2), 111–130. DOI: https://doi.org/10.3390/commodities2020007
Altman, E. I., Iwanicz-Drozdowska, M., Laitinen, E. K., & Suvas, A. (2020). A race for long horizon bankruptcy prediction. Applied Economics, 52(37), 4092-4111. DOI: https://doi.org/10.1080/00036846.2020.1730762
Bandyopadhyay, T. (2018). The status of public sector banks in India today. LiveMint.
Bawa, J. K., Goyal, V., Mitra, S. K., & Basu, S. (2019). An analysis of NPAs of Indian banks: Using a comprehensive framework of 31 financial ratios. IIMB Management Review, 31(1), 51–62. DOI: https://doi.org/10.1016/j.iimb.2018.08.004
Chandrasekhar, C. P., & Ghosh, J. (2017). A crisis is building up in India’s real estate sector. The Hindu Business Line.
Coats, P. K., & Fant, L. F. (1993). Recognizing financial distress patterns using a neural network tool. Financial Management, 22(3), 142–155. DOI: https://doi.org/10.2307/3665934
Das, S. K., & Rawat, P. S. (2018a). Dimensions of NPAs in Indian scheduled commercial banks. Institute for Studies in Industrial Development.
Das, S. K., & Rawat, P. S. (2018b). Understanding NPAs in Indian banks: An analysis of the role of banks and corporate sector. Institute for Studies in Industrial Development.
Davis, E. P. (1994). Banking, corporate finance, and monetary policy: An empirical perspective. Oxford Review of Economic Policy, 10(4). DOI: https://doi.org/10.1093/oxrep/10.4.49
Du, J., & Li, D. D. (2007). The soft budget constraint of banks. Journal of Comparative Economics, 35(1), 108–135. DOI: https://doi.org/10.1016/j.jce.2006.11.001
Fazzari, S. M., Hubbard, R. G., Petersen, B. C., Blinder, A. S., & Poterba, J. M. (1988). Financing constraints and corporate investment. Brookings Papers on Economic Activity, 1988(1), 141. DOI: https://doi.org/10.2307/2534426
Ghosh, S. (2005). Does leverage influence banks’ non-performing loans? Evidence from India. Applied Economics Letters, 12(15), 913–918. DOI: https://doi.org/10.1080/13504850500378064
Ghosh, S. (2017). Ownership, evergreening, and crisis: An analysis of bank–firm relationships in India. Macroeconomics and Finance in Emerging Market Economies, 11(2), 169–194. DOI: https://doi.org/10.1080/17520843.2017.1313753
Heyliger, W. E., & Holdren, D. P. (1991). Predicting small bank failure. Journal of Small Business Finance, 1(2), 1–18. DOI: https://doi.org/10.57229/2373-1761.1117
Hoshi, T., Kashyap, A., & Scharfstein, D. (1993). The choice between public and private debt: An analysis of post-deregulation corporate financing in Japan. NBER Working Paper No. 4421. DOI: https://doi.org/10.3386/w4421
International Monetary Fund (IMF). (2023). Global Financial Stability Report: Safeguarding Financial Stability Amid Macro-Financial Shocks. International Monetary Fund. Retrieved from https://www.imf.org/en/Publications/GFSR
Jing, Z., & Fang, Y. (2018). Predicting US bank failures: A comparison of logit and data mining models. Journal of Forecasting, 37(2), 235–256. DOI: https://doi.org/10.1002/for.2487
Kornai, J. (1979). Resource-constrained versus demand-constrained systems. Econometrica, 47(4), 801. DOI: https://doi.org/10.2307/1914132
Kornai, J. (1980). Economics of shortage. North-Holland Pub. Co.
Kornai, J., Maskin, E., & Roland, G. (2003). Understanding the soft budget constraint. Journal of Economic Literature, 41(4), 1095–1136. DOI: https://doi.org/10.1257/jel.41.4.1095
Lokare, S. M. (2014). Re-emerging stress in the asset quality of Indian banks: Macro-financial linkages. RBI Working Paper Series.
Lu, D., Thangavelu, S. M., & Hu, Q. (2005). Biased lending and non-performing loans in China’s banking sector. Journal of Development Studies, 41(6), 1071–1091. DOI: https://doi.org/10.1080/00220380500155361
Martin, D. (1977). Early warning of bank failure: A logit regression approach. Journal of Banking & Finance, 1(3), 249–276. DOI: https://doi.org/10.1016/0378-4266(77)90022-X
Maskin, E., & Xu, C. (2001). Soft budget constraint theories: From centralisation to the market. The Economics of Transition, 9(1), 1–27. DOI: https://doi.org/10.1111/1468-0351.00065
Máté, D., Raza, H., & Ahmad, I. (2023). Comparative analysis of machine learning models for bankruptcy prediction in the context of Pakistani companies. Risks, 11(10), 176. DOI: https://doi.org/10.3390/risks11100176
Minsky, H. P. (2008). Stabilizing an unstable economy. McGraw Hill Professional.
Misra, B. M., & Dhal, S. (2010). Pro-cyclical management of banks’ non-performing loans by the Indian public sector banks. BIS Asian Research Papers, 16.
Myers, S. C., & Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13(2), 187–221. DOI: https://doi.org/10.1016/0304-405X(84)90023-0
Ohlson, J. A. (1980). Financial ratios and the probabilistic prediction of bankruptcy. Journal of Accounting Research, 18(1), 109–131. DOI: https://doi.org/10.2307/2490395
Organisation for Economic Co-operation and Development (OECD). (2023). Banking on Democracy: Political Rents and Private Lending in Emerging Markets. OECD Publishing. Retrieved from https://www.oecd.org/finance/
RBI. (2013). Banking structure in India: The way forward. Reserve Bank of India.
RBI. (2018). Financial Stability Report. Reserve Bank of India.
Rebello, J., & Ray, A. (2019). With IBC about to be 3, a look at the hits and misses and the road ahead. The Economic Times.
Reinhart, C. M., & Rogoff, K. S. (2011). From financial crash to debt crisis. American Economic Review, 101(5), 1676–1706. DOI: https://doi.org/10.1257/aer.101.5.1676
Robinson, J. A., & Torvik, R. (2023). The influence of government bailouts on NPA proliferation in state-owned enterprises. Springer Economic Studies.
Roy, R. B. (2019). Union Budget 2019: Banking stocks rise on ₹70,000 cr recapitalisation of public lenders. Business Today.
Ruiz, C., Spiegel, M. M., & Takáts, E. (2016). The political economy of bank lending: Evidence from an emerging market. World Bank Blogs.
Schüle, T. (2018). Forbearance lending and soft budget constraints in multiple bank financing. Journal of Institutional and Theoretical Economics, 163(3), 448–466. DOI: https://doi.org/10.1628/093245607781871417
Sengupta, R., & Vardhan, H. (2017). Non-performing assets in Indian banks. Economic and Political Weekly, 52(12), 85–96.
Thakor, A. V., & Yu, L. (2023). Endogenous money, soft budget constraints, and banking regulation. Acta Oeconomica, 73(S1). DOI: https://doi.org/10.1556/032.2023.00036
Tian, L., & Estrin, S. (2007). Debt financing, soft budget constraints, and government ownership. Economics of Transition, 15(3), 461–481. DOI: https://doi.org/10.1111/j.1468-0351.2007.00292.x
Vilén, M. (2010). Predicting failures of large U.S. commercial banks. Aalto University.
West, R. C. (1985). A factor-analytic approach to bank condition. Journal of Banking & Finance, 9(2), 253–266. DOI: https://doi.org/10.1016/0378-4266(85)90021-4
World Bank. (2023). The Political Economy of Bank Lending: Evidence from Emerging Markets. World Bank Blogs. Retrieved from https://openknowledge.worldbank.org/
Zeineb, A., & Rania, H.-K. (2016). Predicting US banks bankruptcy: Logit versus canonical discriminant analysis. Centre for Economics at the Sorbonne.
Authors
Copyright (c) 2024 Dilawar Ahmad Bhat, Udayan Chanda, Anil K. Bhat
This work is licensed under a Creative Commons Attribution 4.0 International License.