TY - JOUR
T1 - Where is credit due? Legal institutions, connections, and the efficiency of bank lending in vietnam
AU - Malesky, Edmund J.
AU - Taussig, Markus
N1 - Funding Information:
We would like to thank US-AID’s Vietnam Competitiveness Initiative for supplying data necessary for our analysis and Chris Woodruff, Josh Lerner, Thorsten Beck, Gordon Hanson, Nick Freeman, Susan Adams, Martin Gainsborough, and two excellent reviewers for their helpful comments and advice. All mistakes are our own. Edmund Malesky would also like to thank the Harvard Academy and UCSD Junior Faculty Grants for funding during the course of the study.
PY - 2009/10
Y1 - 2009/10
N2 - Rapid development of the domestic private sector in communist China and Vietnam has been offered as evidence against a large literature that claims a solid legal infrastructure is required for the financial sector to contribute to economic development. One component of the counterargument holds that relationship-based lending has served as an effective substitute for legal institutions. In this article, we challenge this assertion with empirical findings that show bank credit allocation that relies heavily on "connections" undermines the impact of finance on investment growth. Our data come from Vietnam, where - like China - the private sector and financial sector are expanding dramatically but rule of law has not kept pace. Although Vietnam's banking sector is in transition toward a healthier system, it still allocates a disproportionate share of credit to "connected" enterprises in less competitive regions. We find that political connections, in particular, are an ineffective tool for channeling bank credit to the most profitable investors. Using a two-stage empirical approach, we find evidence that banks place greater value on connections than performance and that the firms with greater access to bank loans are no more profitable than firms without them. By some measures, connected firms are even significantly less profitable. We conclude by demonstrating that the most profitable investors in Vietnam have forgone the formal banking system, preferring to finance their activities out of reinvested earnings or informal loans (JEL G21, G28, G30, O12, K11).
AB - Rapid development of the domestic private sector in communist China and Vietnam has been offered as evidence against a large literature that claims a solid legal infrastructure is required for the financial sector to contribute to economic development. One component of the counterargument holds that relationship-based lending has served as an effective substitute for legal institutions. In this article, we challenge this assertion with empirical findings that show bank credit allocation that relies heavily on "connections" undermines the impact of finance on investment growth. Our data come from Vietnam, where - like China - the private sector and financial sector are expanding dramatically but rule of law has not kept pace. Although Vietnam's banking sector is in transition toward a healthier system, it still allocates a disproportionate share of credit to "connected" enterprises in less competitive regions. We find that political connections, in particular, are an ineffective tool for channeling bank credit to the most profitable investors. Using a two-stage empirical approach, we find evidence that banks place greater value on connections than performance and that the firms with greater access to bank loans are no more profitable than firms without them. By some measures, connected firms are even significantly less profitable. We conclude by demonstrating that the most profitable investors in Vietnam have forgone the formal banking system, preferring to finance their activities out of reinvested earnings or informal loans (JEL G21, G28, G30, O12, K11).
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U2 - 10.1093/jleo/ewn011
DO - 10.1093/jleo/ewn011
M3 - Article
AN - SCOPUS:71949124748
SN - 8756-6222
VL - 25
SP - 535
EP - 578
JO - Journal of Law, Economics, and Organization
JF - Journal of Law, Economics, and Organization
IS - 2
ER -