Centre for Development Economics
Department of Economics, Delhi School of Economics


Regulatory Intervention To Aid Legal Reform




Thursday, 5th September 2019 at 3:05 PM

Venue : Seminar Room (First Floor)
Department of Economics, Delhi School of Economics

All are cordially invited

Poor bankruptcy laws can result in entrenched systems of evergreening in developing countries. We exploit, as a natural experiment, the introduction of a new bankruptcy law in India and examine likelihood of loans being classified as distressed, a precursor to starting bankruptcy proceedings. We find that the bankruptcy law had only a limited impact on banks classifying loans as delinquent, and the impact was particularly muted for weaker banks. A subsequent regulatory intervention implemented by the Reserve Bank of India removed lender discretion in recognizing loans as distressed and in initiating subsequent bankruptcy proceedings. Using variations in the applicability of the new regulations across borrower size, we show that the regulatory intervention resulted in a significant increase in recognition of distressed assets with the effects being present also in weaker banks. As a result, credit was reallocated away from distressed firms and towards investment-grade firms. Overall, our results suggest that bank health is an important determinant of the effectiveness of bankruptcy reform and regulatory intervention can successfully overcome poor enforcement arising from a weakly capitalized banking sector.

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