Connected Lending: Thailand before the Financial Crisis*

Abstract

The allocation of credit by banks and financial institutions on 'soft' terms to friends and relatives rather than on the basis of 'hard' market criteria in the years leading up to the East Asian crisis of 1997-98 has been widely noted. Using a detailed dataset on Thai firms prior to the crisis period we examine whether business connections were in fact a good predictor of preferential access to long term bank credit. We find that firms with connections to banks and politicians had greater access to long-term debt than firms without such ties. Connected firms need much less collateral to obtain long term loans than those without connections.Such firms obtain more long term loans, and appear to use less short term loans. We do not find support for the existence of connections between banks and firms serving to reduce asymmetric information problems. Our results thus lend support to the hypothesis that the presence of connections was the most important factor determining access to long term bank debt prior to the financial crisis and are consistent with recent research implicating weak corporate governance in the extent and severity of the crisis.JEL Classification: G30, G32

Connected Lending and Aggregate Productivity

“…This, therefore, indicates that connected lending is more consistent with the crony view than the information view. This is consistent with the result of Charumilind et al (2006). They show that special connections between Thai firms and Thai banks do not reduce the asymmetric information problem between them.…”

“…Thus, firms having the same characteristics except connections may end up with different amounts of capital. Charumilind et al (2006) also show that connected firms have total assets and sales much more than unconnected ones. Connected lending is also prevalent in many other countries including Mexico and Russia.…”

“…Most large Thai firms and banks are controlled by a handful number of families and are connected by shareholding or personal relationship. Charumilind, Kali, and Wiwattanakantang (2006) found that Thai firms which are connected to prominent families have better access to long-term loans than firms without such connections. Since an investment is better facilitated by long-term loans, firms with better access to such loans should be more capable to acquire capital.…”

“…Since there is no reliable data on connected lending and special connections with financial intermediaries, 1 is set to 0.22, which is the fraction of firms connected to the top 20 wealthiest families reported by Charumilind et al (2006). and are set to match the ratio of external finance to GDP.…”

Political connections, bank deposits, and formal deposit insurance

“…On the one hand, some empirical studies find that the benefits of political connections are i) an easier access to financial resources such as bank loans or others funds at more convenient conditions (Charumilind et al, 2006;Claessens et al, 2008;Fraser et al, 2006;Khwaja and Mian, 2005;Li et al, 2008); ii) a build up confidence in the legal system (Li et al, 2008); iii) an improved performance (Johnson and Mitton, 2003); iv) a higher probability of being bailed out ; v) an increase in firm value by, for example, increasing its stock value (Goldman et al, 2009), and vi) a lower cost of equity capital (Boubakri et al, 2012). On the other hand, some studies find negative impacts of being politically connected firms such as i) lower quality of accounting information (e.g.…”