Indirect Evergreening Using Related Parties: Evidence From India - with Sriniwas Mahapatro and Prasanna Tantri

Published in Journal of Financial and Quantitative Analysis (JFQA)

Abstract: We identify a novel way of evergreening loans in India. A low-quality bank lends to a related party of an insolvent borrower, and the loan recipient transfers the funds to the insolvent borrower using internal capital markets. Incremental investments, interest rates charged, and loan delinquency rates collectively indicate evergreening. These loans are unlikely to represent arm’s length transactions or rescue of troubled related firms by stronger firms to prevent group-wide spillover effects. Indirect evergreening is less likely to be detected by regulatory audits. It has significant real consequences at the firm and industry levels.

Preventing Defaults In Response to Deteriorating Bank Health: The Prompt Corrective Action Approach - with Sriniwas Mahapatro and Prasanna Tantri
(Conditionally Accepted at Contemporary Accounting Research)

Abstract: We ask whether regulatory intervention in the form of prompt corrective action (PCA), which seeks to cure troubled banks through temporary restrictions and increased monitoring, reverses defaults in response to deteriorating bank health. Using the Indian PCA regime and exploiting the discontinuity in the entry criteria in a regression discontinuity framework, we find that the intervention reduces defaults by 1.1 times. The results are robust to variation in methodology and definition of bank health. Evidence suggests that the mechanism is the intervention’s ability to signal to the borrowers about the likely restoration of bank health and continuation of banking relationships.

Financial Acceleration Through Banks - with Sriniwas Mahapatro and Prasanna Tantri

Abstract: Holmstrom and Tirole (1997) show that financial accelerators amplify demand shocks due to changes in firms’ and banks’ net worth. Extant studies focus more on the firm net worth channel and do not provide micro-evidence for the full chain of events in financial acceleration models. We find a novel bank net worth channel of financial acceleration that operates through the banks’ exposure to price-rigid borrowers. This channel exacerbates the effects of monetary policy shocks on price-rigid firms and causes spillover effects on non-price-rigid firms. In terms of relative magnitude, the two channels contribute equally to the overall financial acceleration effect.

What do ESG funds deliver? - with Shashwat Alok and Nitin Kumar

Abstract: We examine the ESG portfolio rating and performance of funds that identify themselves as ESG funds. We first introduce a standard definition of ESG funds using objective data from prospectuses. We find that ESG funds cost more to investors as compared to conventional funds. Yet ESG funds fail in their primary mandate to deliver a higher ESG-rated portfolio than conventional funds. Furthermore, the internal governance of these funds is also not different from each other. However, ESG funds deliver higher risk-adjusted returns than conventional funds. We conclude that some skilled conventional funds brand themselves as ESG funds and charge higher fees but do not deliver superior ESG-rated portfolios.

Do improvements in creditor rights dampen the financial acceleration of monetary policy shocks?

Abstract:  Using the changes in bankruptcy laws in India as a setting, I show that the enhancement in creditor rights results in a decline in the transmission of monetary policy shocks to lending and investment. Evidence indicates that the underlying mechanism is the decline in the amplification of monetary policy shocks due to financial acceleration after the increase in creditor rights. Finally, I show that the transmission of policy shocks to lending rates and firms' investments also declines. The results are robust to multiple identification strategies, alternative definitions of monetary policy shocks, and different levels of fixed effects.

Do intermediaries help mitigate the contagious effects of runs? - with Raja Reddy Bujunoori, Prasanna Tantri, and Vikrant Vig

Abstract: In this paper, we examine the behavior of financial intermediaries during a run involving mutual funds and shadow banks. Our setting is based in India where investors fund shadow banks via debt mutual funds. For our analysis, we exploit the unexpected failure of a large shadow bank. The failure of a shadow bank potentially signals distress in the industries where it operates. Investors plausibly revised their beliefs after this information event and exited mutual funds with a high allocation to shadow banks, irrespective of whether these banks operate in similar industries as the failed shadow banks (affected shadow banks). This investor response would have spread contagion to shadow banks operating in different industries (unaffected shadow banks). Mutual funds, however, selectively reduced allocation to affected shadow banks and shielded unaffected ones from the investor run. On the other hand, closed-end funds facing no redemption pressure held onto their allocation in shadow banks. Therefore, the fundamentals themselves did not warrant liquidation. Overall, the intermediary's choice to liquidate certain shadow banks minimized the inefficiency caused by the run. We highlight this liquidation choice as a hitherto unexplored role of intermediaries.

What Happens to Quantity Transmission When Monetary Policy Transmission Through Prices is Mandated? - with Ashirbad Mishra and Prasanna Tantri

Abstract: Using a unique policy experiment in India where the central bank mandated banks to pass on policy rates almost one-to-one to small firms, we examine how such a mandate impacts the responsiveness of loan quantity to policy rate cuts. We find that the loan amounts expand less under the mandate than before. We show that banks’ inability to spend on monitoring when forced to pass on rate cuts is the main mechanism. Firm-level investments and local-level economic growth also respond relatively slowly to policy rate cuts in a regime with increased interest rate transmission.

Firm Market Power Channel of Transmission of Monetary Policy - with Prasanna Tantri

Abstract: We show that in the presence of financial frictions, the transmission of monetary policy shocks to prices can slow down due to changes in markups induced by variations in market concentration levels. We use a natural experiment provided by a change in eligibility requirements for Indian small firms for a directed lending program. The newly eligible firms became exogenously less financially constrained. Using the presence of such firms at an industry level, we show that a rate hike (cut) increases (reduces) market concentration levels and markups, leading to a slower transmission of monetary policy shocks to prices.

Bank Cleanups and Shadow Bank Lending: Evidence from India - with Saikat Sovan Deb and Mike Mao

Abstract: We examine the effect of a special audit of banks' asset quality in India on the quality of shadow bank lending. Though the consequent undercapitalization of banks leads to their underinvestment and risk-shifting, we find increased lending by shadow banks to low-risk firms, especially in areas more affected by the exercise. Firms and districts with a larger exposure to shadow banks see less reduction in investments and project activities. Overall, we show that shadow banks provide an alternative source of funding for low-risk borrowers and help offset the negative effects of bank liquidity shocks on investment.