THE IMPACT OF STATE OWNED BANK LENDING ON FIRM INVESTMENT DURING THE 2007-2008 FINANCIAL CRISIS: EVIDENCE FROM INDIA

Abstract

This study uses India as a natural experiment to investigate the effect of state owned bank lending on capital investment for publicly-traded non-financial firms during the recent 2007-2008 financial crisis. In particular, I study the effect of state owned bank lending on firms with exclusive state owned bank loans. The results show that in general, state owned bank lending has an indirect incremental effect on firm investment, in terms of increasing Tobin’s q sensitivity and reducing cash flow sensitivity. This positive effect continues into crisis periods, where firms with state owned bank lending have larger Tobin q effect and lower cash flow effect on investment. I also find state owned bank lending to be unique; particularly by showing that private bank lending does not have an incremental effect on investment during the same distress period. Likewise, the incremental effect of state owned bank lending does not exist for less credit-constrained firms with both state owned and private bank lending in the same year. In an extension of my study, I investigate the impact of state owned bank lending on firm profitability. While the accounting profitability of firms with exclusive state owned bank lending are comparable to its peers, they show better performance in the long term, for both non-crisis and crisis periods. While the consolidated findings on the effect of state owned bank lending on firm investment and profitability seem to support the social view on government ownership of banks that state owned banks maximizes social welfare, the political and agency view on state owned banks cannot be entirely ruled out.