Are the Monitors Over-Monitored? Evidence from Corruption, Vigilance, and Lending in Indian Banks

Most credit in India is provided by public-sector banks. Previous research has found that loan officers in public banks decline profitable lending opportunities, and are strikingly reluctant to enhance loans of growing and profitable firms. Loan officers in government owned banks often cite fear of prosecution for corruption as a reason for their rigid and conservative lending decisions. Using data from all commercial banks, from 1981 to 2003, we test this claim, using an event-study methodology to examine how lending decisions react to vigilance activity. We find evidence that vigilance activities result in reduced lending: the amount of credit declines sharply at the affected bank branch, as well as neighboring branches. This effect is economically and statistically significant, persisting up to two years. Bank risk-taking also declines following a vigilence event. ∗MIT ([email protected]), Harvard Business School ([email protected]), and MIT ([email protected]), respectively. †This work is a collaborative exercise with research staff from the Reserve Bank of India, who performed much of the statistical analysis in this paper. The statements made in this paper do not in any way represent the view of the Reserve Bank of India or its employees.