Home / News / World /  Reckless borrowing linked to credit booms

Reckless borrowing by companies and misallocation of credit by banks during economic booms have been discussed in detail for long. A recent study, by Saumitra Bhaduri and Ekta Selarka of the Madras School of Economics, has attempted to quantify the extent and nature of such borrowing exuberance in India.

Most existing studies look at what happens after a period of indiscriminate lending, such as non-performing loans. However, Bhaduri and Selarka adopt an ex ante approach to the problem—that is, analysing what leads to it rather than what happens after.

The authors track the time periods in which India witnessed corporate borrowing exuberance. They use data from the Centre for Monitoring Indian Economy to analyse firms with long-term borrowing between 1990 and 2017. A measure developed by the authors shows that India’s corporate borrowing exuberance saw two high-intensity periods—once soon after liberalization, during 1994-1997 with a peak in 1995, and again during 2004-2008 with a peak in 2006, when the economy saw high growth rates.

The study finds that during such boom periods, there is a positive link between credit growth and borrowing exuberance—when one grows, the other follows suit. But this also leads to suboptimal lending as banks, due to abundance of credit, end up disbursing loans even to non-creditworthy firms. This indicates laxity and poor judgement from banks in allocating credit, despite having signals on the low quality of such firms, the authors say.

When growth periods subside and credits have to be squeezed, banks tighten up policies and many competitive borrowers lose out on credit, the study says. Thus, inefficient banking can lead to suboptimal allocation of resources, which can adversely affect credit growth and financial stability.

Also read: Corporate borrowing exuberance and credit cycles- some insights from an emerging economy, India

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