PUBLICATIONS
Zombie Lending Due to the Fear of Fire Sales (with Nirupama Kulkarni, CAFRAL and Saurabh Roy, University of Quebec at Montreal) (pdf)
Accepted at Journal of Corporate Finance
Abstract: This paper provides evidence of a new cost of fire sales: zombie lending by banks. Banks with high market share are more likely to internalize the negative spillovers of falling collateral prices during a fire sale. To prevent prices from falling further during a fire sale, these banks do not liquidate defaulted firms and instead give zombie loans to keep them alive. Using structural breaks in real estate prices to identify periods of fire sales in different MSAs, we provide evidence that banks with high market share give zombie loans to firms with relatively higher real estate assets during a fire sale. Further, congestion due to zombie firms in an industry reduces the investment and profitability of healthier firms. Overall, we highlight a new mechanism for zombie lending resulting from reduced collateral liquidation in markets prone to fire sales.
WORKING PAPERS
Ignoring the Left Tail (with Nishant Ravi, ISB) (pdf)
This article studies a principal-agent problem with flexible information acquisition. The agent has to choose between investing in an innovative asset about which costly information can be acquired or in a conventional asset about which there is enough historical data and no information is acquired. In the first-best problem, the principal acquires information about the entire distribution of cash flow from the innovative asset. Contrarily, in the second-best problem, less information is acquired about the left tail of the distribution compared to the first-best. The optimal contract of the agent when the innovative asset is chosen pays zero wage below a cutoff value of cash flow and an increasing wage above the cutoff. As a consequence, the information intensity is zero for these low cash flows where no wage is paid. This results in investment in even those assets that have a thick left tail and thus a high likelihood of failure ex post. Our paper explains why agents make investments without learning about the left tail of the distribution which in turn may lead to a financial crisis.
Career Incentives and Employee Productivity in State-Owned Enterprises: Evidence from India (with Samarth Gupta, Ahmedabad University and Tanisha Agarwal, UT Austin) (pdf)
State-owned enterprises (SOEs) are large and important organizations in many economies but suffer from low labour productivity. Can SOEs improve their labour productivity by enhancing career concerns for their employees? We show that an exogenous change in opportunities to influence career progression significantly improves the performance of employees of state-owned banks in India. In particular, we find that when banking employees get more exposure to senior management, which has discretion in the former’s promotion decisions, employees increase credit expansion on both intensive and extensive margins. Further, this expansion happens through increased productivity, and not costly factors such as liberal screening, lower interest rates or higher resource allocation. Our results show that reforms in performance review processes, which allow workers to signal effort to supervisors in state-owned firms, may yield substantial productivity gains.
Credit Insurance, Bailout and Systemic Risk (pdf)
This paper studies the impact of expectation of bailout of a credit insurance firm on the investment strategies of the counterparty banks. If the failure of credit insurance firm may result in the bankruptcy of its counterparty banks, then the regulator will be forced to bail it out. This imperfectly targeted time inconsistent policy incentivizes the banks to make correlated investments ex ante. All banks want their assets to fail exactly at the time when the bailout is occurring to indirectly benefit from the bailout of the insurance firm and hence they make correlated investments ex ante. I build a model in which a systemically important insurance firm, correlated investment by banks and under priced insurance contracts arise endogenously and show that while credit insurance helps in risk sharing during good times, it can also create systemic risk.
Why Risk Managers? (pdf)
Banks rely on risk managers to prevent their employees from making high risk low value investments. Why can’t the CEOs directly incentivize their employees to choose the most profitable investment? I show that having a separate risk manager is more profitable for banks and is also socially efficient. This is because there is conflict between proving incentive to choose the most profitable investment and providing incentives to exert effort on those investments. Hence, if the tasks are split between a risk manager who approves the investments and a loan officer (or trader) who exerts effort, then both optimal investment choice and optimal effort can be achieved. I further examine some reasons for risk management failure wherein a CEO may ignore the risk manager when the latter is risk averse and suggests safe investments. As is usually the case before a financial crisis, my model predicts that the CEO is more likely to ignore the risk manager when the risky investments are yielding higher profits.
OTHER PUBLICATIONS
Understanding Sovereign Ratings and their Implications for Emerging Economies. Economic and Political Weekly, 2023
(Coauthors: Rahul Chauhan, Ilisa Goenka, Nirupama Kulkarni, Kavya Ravindranath, Gautham Udupa)
WORK IN PROGRESS
State-owned Banks and Financial Stability (with Jash Jain, ISB)
Banking On a Road (with Shilpa Aggarwal, ISB)
Risk Takers and Risk Managers (with Nishant Ravi, ISB)