Do politicians use public sector banks to win elections?

Do politicians use public sector banks to win elections?

India’s public sector banks have often been used for political ends. The days of loan melas (fairs) may be over, but writing off farmers’ loans in order to win their votes is very common. This paper looks at agricultural lending by government banks in India to check whether these banks are being used to woo farmers ahead of elections. The paper focuses on state, rather than federal elections, because the boards of government banks have political appointees and the state-level bankers’ committees also have state government politicians and appointees.

Shawn A. Cole compares agricultural lending by state-owned banks in election years to lending in off-election years and finds the volume of lending rises sharply in election years. That is compelling evidence of banks being used for political purposes and of electoral manipulation of agricultural credit.

Cole finds that “lending by public sector banks is about 6 percentage points higher in election years than non-election years" and that “agricultural credit issued by public banks is lower in the years that were four, three, and two years prior to an election than in the years before an election or election years". Significantly, no such pattern is observed in non-agricultural lending, nor is it evident in lending by private sector banks. How is the extra lending done? By giving farm loans to more borrowers as well as by increasing the size of their loans.

Does this “political" lending result in higher rates of loan default? It certainly does. Cole’s research shows that late payment of loans, which means they are overdue by at least six months, increases by 16% for government banks during election years, relative to the two years prior to the election. The increase in bad loans is not only because the volume of credit is increasing—the difference from peak to trough in credit volume is 8%, but it is 15% for the volume of loans in default. Such a high rate of default implies that loans were not made on a commercial basis.

Interestingly, though, the study also finds that defaults come down in the year after elections, possibly the result of newly elected governments implementing their poll promises of writing off farmer’s loans.

The study shows that politicians reward their supporters immediately following elections, by causing banks to write off loans to borrowers in constituencies in which politicians enjoyed the greatest support.

Cole also shows that the amount of credit during election years going to districts that have a low margin of victory, or the ones where the election fight is a tough one, is larger than that going to other constituencies. The research quantifies it precisely, pointing out that “a district in which the ruling party won (or lost) an election by 15 percentage points will receive approximately 5-6% less credit than a district in which the previous election was narrowly won or lost".

Is there a saving grace that the increased farm lending during election years leads to higher agricultural output and is, therefore, good for the country? Unfortunately, the paper finds no such evidence.

Cole concludes by saying, “Arguments against government ownership of banks typically rest on two premises: Government enterprises are less efficient, and their resources are misused by politicians. This paper provides a clear example of the latter, and suggests that the costs of misuse are so great that additional government credit may have no effect on output."

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