Bank Entry and Bankruptcy
Todd Gormley, Nandini Gupta, and Anand Jha
* † March 11, 2010Abstract
The bankruptcy process often involves long delays that erode firm value and raise the cost of capital. Using a unique dataset on corporate bankruptcy filings and geographic variation in bank entry following deregulation of the banking sector in India, we investigate whether entry in the banking sector is related to changes in the bankruptcy process based on the hypothesis that increased competition among banks may change creditor incentives towards monitoring or exerting pressure on defaulting borrowers. The results show that private bank entry in a region is associated with an increase in bankruptcy filings by nearby firms. Despite the increase in filings, private bank entry is also associated with a significant decrease in delays in the bankruptcy process. Foreign bank entry is associated with more bankruptcies when creditor rights are stronger. Hence, bankruptcy reforms that focus on changes in the law should also take into account local financial market factors such as the competitiveness of the banking sector.
Keywords: Bankruptcy, bank competition, bank ownership, creditor rights, India
*
Gormley is at The Wharton School, University of Pennsylvania, Phone: (215) 746-0496, E-mail: [email protected]. Gupta is at the Kelley School of Business, Indiana University, Phone: (812) 855-3416, E-mail: [email protected]; Jha is at Texas A&M International University, Phone: (956) 326-2581, E-mail: [email protected].
†
We are grateful to Franklin Allen, Irina Stefanescu, Greg Udell, and Vijay Yerramilli for valuable comments. We also thank participants of the finance department workshops at the Kelley School of Business, The Wharton School, and the Hong Kong University of Science and Technology Corporate
1. Introduction
Bankruptcy procedures are a way of enforcing debt contracts, and the efficiency of this process can affect the cost of capital for firms and the efficiency of resource allocation (Stiglitz, 2001 and Hart 2000). However, the bankruptcy process can be highly inefficient, especially in developing countries. For example, the average duration of bankruptcies ranges from 3 to 7 years in emerging markets such as Brazil, India, Indonesia, and Russia compared to 1.5 years in the United States (World Bank, 2010). In a survey of insolvency practitioners in 88 countries, Djankov, Hart, McLiesh, and Shleifer (2008) estimate that on average nearly 50% of firm value is lost during the bankruptcy process due to inefficiencies and delays. While there is a large literature that focuses on how differences in bankruptcy law may explain these inefficiencies, we take a different perspective in this paper and investigate the role of creditors. Specifically, we investigate whether bank entry and the ownership of banks is related to the incidence, outcome, and duration of corporate bankruptcies in India.
Banking sector competitiveness may increase managerial incentives to maximize efficiency (Hicks, 1935; Berger and Hannan, 1998), and affect the supply of credit (Rice and Strahan, 2009). Thus, a more competitive banking sector may increase creditors’ incentives to aggressively monitor borrowers or recover assets more quickly, which in turn can increase a firm’s likelihood of seeking bankruptcy protection and reduce the amount of time firms spend in bankruptcy. The ownership of creditors may also affect their incentive to monitor loans. For example, privately-owned banks may have a stronger incentive to pursue delinquent firms and recover assets quickly relative to government-owned banks.
To investigate the impact of creditors’ incentives on bankruptcy outcomes, we examine how bank entry in a region is related to corporate bankruptcy outcomes in that region using data on India. While the bankruptcy process is implemented at the federal level, there is significant variation in regional banking markets following entry deregulation in the early 1990s. Deregulation facilitated the entry of private domestic and foreign banks into a sector previously
dominated by monopolistic government banks.
Using India as the empirical context has several additional advantages. The high share of assets held by government banks is similar to that of other developing economies (La Porta, Lopez-de-Silanes, and Shleifer, 2002), and as in other emerging markets, bankruptcies can take a long time to resolve (It takes 7 years on average for firms to emerge from bankruptcy in India (World Bank, 2010)). Another advantage is the availability of detailed data on corporate bankruptcy filings in India. In particular, we observe the population of bankruptcy filings since 1991 that are filed with the federal bankruptcy court, the Board for Industrial and Financial Restructuring (BIFR). All industrial firms with more than 50 workers, that are at least 5 years old, and meet certain financial conditions, are required to file for bankruptcy with this court.
Making use of variation in both the timing and the extent of bank entry across India’s more than 500 districts, we find that an increase in banking sector competition, as measured by the Herfindahl index of bank deposits, is associated both with an increase in the number of corporate bankruptcy filings and a significant decrease in the average duration of bankruptcy. Disaggregating the competition effects by bank ownership, we find that bankruptcy outcomes depend not just on the general competitiveness of the banking sector, but also on the ownership of banks. Specifically, a one standard deviation increase in the share of deposits controlled by private banks in a district is associated with a one standard deviation increase in the number of bankruptcy filings in that district.
Despite the increase in bankruptcy filings, which may increase the burden on the bankruptcy court, private bank entry is associated with an economically significant decrease in delays in the bankruptcy process. Following a one standard deviation increase in the share of deposits held by private banks in a district, the average number of days taken to receive a restructuring or liquidation order from the bankruptcy court decreases by about 422 days (14 months). Private bank entry is also associated with a shift away from liquidation orders in favor
of more restructuring decisions, and a larger decrease in the duration of restructurings relative to liquidations. Foreign bank entry, however, appears to have little average relationship to bankruptcy outcomes, suggesting that foreign banks may face more difficulty navigating local bankruptcy procedures.
We also examine the association between bank entry, bankruptcy, and creditor rights, which are likely to facilitate lenders’ ability to influence the bankruptcy process. Starting in 1993, the Indian government introduced specialized courts to speed up the resolution of debt recovery claims. Using the staggered introduction of these courts to capture changes in creditor rights across regions, we find that the positive association between private bank entry and bankruptcy filings is larger when creditor rights are stronger, and foreign bank entry is also associated with an increase in filings in regions with stronger creditor rights.
The relationship between private bank entry and bankruptcy outcomes does not appear to reflect an omitted variable related to banks’ endogenous location choice. Specifically, we include district-level fixed effects to capture time-invariant differences across districts, and year dummies to capture country-level trends in bankruptcy outcomes. Our findings are also robust to controlling for other district-level factors that may be related to both bank entry and bankruptcy outcomes, such as district-level growth and the share of loans allocated to government-owned firms. The shift in bankruptcy filings also occurs between one to two years after bank entry, suggesting the relationship is not driven by a simultaneity bias where bankruptcies instead drive bank entry.
The relationship between bank entry and bankruptcy filings also depends on whether the filing firm is government or privately-owned. While the entry of private banks in a market is accompanied by an increase in filings by privately-owned firms, it has the opposite effect on government-owned firms. This suggests that private banks may be limited in their ability to pursue delinquent government-owned firms.
Our evidence suggests that private bank entry affects the incentive of creditors to aggressively pursue repayment and speedily recover loans. The increase in frivolous filings following private bank entry, suggests that firms are seeking the protection of bankruptcy to avoid increased creditor scrutiny.1 The shift to restructurings away from costly liquidations, which are typically subject to legal challenges that can take many years to resolve, and the significant decrease in delays in the bankruptcy process, may also reflect private lenders’ incentives to recover assets more quickly by making concessions to resolve a restructuring decision.
Bank entry may also affect bankruptcy outcomes through other channels. For example, bank entry may be associated with a change in the supply of credit or a change in the pool of borrowers. However, our findings do not appear to be driven by a change in the supply or allocation of credit, which may affect product market competition, or the type of firms receiving credit. The findings are robust to controlling for the district level supply of credit, and we also do not find evidence suggesting that bank entry may affect the types of firms filing for bankruptcy. Our main results are also robust to controlling for the financial characteristics of firms filing for bankruptcy.
An important implication of our results is that less competitive banking sectors and the government ownership of banks may contribute to the extreme inefficiency of some bankruptcy systems by reducing managerial incentives to monitor borrowers. These results complement the large literature that analyzes how differences in bankruptcy laws may affect the bankruptcy process (see Hotchkiss, John, Mooradian, and Thorburn (2008) for an extensive survey of this literature). To the best of our knowledge, however, ours is the first paper to look at the relationship between banking sector characteristics and bankruptcy outcomes. We also contribute
1
It is widely acknowledged that the stay on all creditor claims once a firm files for bankruptcy in India creates an incentive for firms to file in order to avoid creditors, and the automatic stay has been “grossly misused by unscrupulous firms” (Government of India, 2002).
to the law and finance literature by showing that an increase in creditor incentives to monitor borrowers combined with stronger creditor rights may affect the use of bankruptcy. For example, Claessens and Klapper (2005) find that controlling for judicial efficiency, bankruptcy tend to be used more frequently in countries with stronger creditor rights, suggesting that institutional characteristics such as the court system can affect the resolution of financial distress. Our results suggest that the effect of creditor rights may also depend on the competitive characteristics of the financial sector.
The evidence presented here also offers insight into why outcomes may vary within a given bankruptcy process. Existing empirical studies have focused on the complexity of debt arrangements (Gilson, John and Lang, 1990), managerial incentives (Eckbo and Thorburn, 2003), role of Japanese “keiretsu” banks (Hoshi, Kashyap and Scharfstein, 1990), and differences across bankruptcy judges (Chang and Schoar, 2007). In contrast, we provide evidence that bank entry and bank ownership may also affect bankruptcy outcomes. This focus on the role of creditors is also related to recent evidence that creditors adjust their lending practices ex-ante at the time of loan origination in response to differences in creditor rights (Qian and Strahan, 2007 and Davydenko and Franks, 2008). We provide evidence suggesting that banking sector characteristics can also play an important role in the ex-post monitoring of borrowers.
Our paper is related to the large literature on the effects of banking sector competition. Recent evidence suggests that financial sector competition may affect firms’ access to credit (Petersen and Rajan, 1995, Beck, Demirguc-Kunt, and Maksimovic, 2004, and Zarutskie, 2006), entrepreneurship (Black and Strahan, 2002), economic growth (Jayaratne and Strahan, 1996, Cetorelli and Gambera, 2001), firm size and market structure (Cetorelli and Strahan, 2006), access to credit for underperforming firms and product market competition (Bertrand, Schoar, and Thesmar, 2007), and the proportion of bad loans (Guiso, Sapienza, and Zingales, 2007).
There is also evidence to suggest that government ownership of banks is associated with less developed financial markets and slower economic growth (La Porta, Lopez-de-Silanes, and Shleifer, 2002), less efficient banks (Barth, Caprio, and Levine, 2004), financing constraints (Beck, Demirguc-Kunt, and Maksimovic, 2004), politically motivated lending (Sapienza, 2004), and inefficient capital allocation (Morck, Yavuz, and Yeung, 2008). Our study suggests that banking sector entry and ownership can also affect the ex-post monitoring of borrowers and thereby bankruptcy outcomes, which may have important implications for firms’ financing and investment choices.
Our paper is organized as follows: Section 2 describes the Indian bankruptcy process and banking sector, Section 3 describes the data, Section 4 describes the main results, Section 5 analyzes the role of creditor rights, Section 6 provides a number of robustness checks, and Section 7 concludes.
2 The Bankruptcy Process and Banking Sector in India 2.1 Bankruptcy in India
We focus on the bankruptcy rules under the Sick Industrial Company Act (SICA) of 1985, which governs the vast majority of cases and is the most commonly used process for filing for bankruptcy (Panagariya, 2008). SICA applies to all industrial firms that employ more than 50 workers and have been in operation for over 5 years. While in the United States, firms filing for liquidation do so under Chapter 7, and firms filing for reorganization do so under Chapter 11, SICA provides a platform for both the renegotiation of loans and liquidation of the firm. However, this process is extremely inefficient, with average delays of more than 4 years before the bankruptcy court renders a decision about whether the firm is to be restructured or liquidated. Subsequent to the bankruptcy court’s decision, there are further delays in the civil courts that carry out the liquidation process, which can take 10 years or more (Panagariya, 2008).
We also examine the Recovery of Debts due to Banks and Financial Institutions Act (RDDBFI Act), which was enacted in 1993 by the Indian government to strengthen creditor rights by introducing new rules for the recovery of large debts. 2
2.1.1 Sick Industrial Company Act (SICA) of 1985.
When a company files under the jurisdiction of SICA, it files at the Board for Industrial and Financial Reconstruction (BIFR), which is the federal bankruptcy court. The BIFR was set up in 1987 to provide timely detection of sick industrial companies. There is just one bankruptcy court, located in the nation’s capital of New Delhi, which oversees bankruptcy cases for the whole economy. To compare, there are 94 regional courts in the United States (Hotchkiss, John, Mooradian, and Thorburn, 2008). We examine the population of bankruptcy filings at the BIFR since 1991.
The conditions for filing with the BIFR are as follows: It is mandatory for the board of directors to file at the BIFR once the firm is “sick”, where a firm is determined to be sick when its book value is equal to zero. The other requirements for filing are: Contributed capital should be less than accumulated losses (i.e, book-value of the firm is zero); firms should be at least 5 years old; and, employ at least 50 workers. SICA allows the board of directors to file at the BIFR even if the balance sheet does not show that the firm is sick, but the directors are of the opinion that the firm will meet the criteria of sickness in the near future (SICA, Section 15(1)). Creditors or the government may also file for bankruptcy, but there is little incentive for creditors to do so given the automatic stay on assets and the delays at BIFR. The same is true in the United States, where bankruptcy filings are mainly initiated by managers (Hotchkiss, John, Mooradian, and Thorburn,
2
The government enacted the Companies Act in 2002 to address the weaknesses of SICA, but this law is yet to be implemented because of legal challenges. It also passed the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests Act in 2002, which allowed secured creditors to recover assets without court intervention. We discuss the potential effect of this law later.
2008). In fact the majority of banks and financial institutions in India remain highly dissatisfied with the BIFR: “In a meeting on August 30 in the banking division, Finance Ministry, under whose supervision BIFR functions, banks and financial institutions almost unanimously asked the Government to down shutters on the board, official sources said,” (The Daily Excelsior, September 14, 1999).
A key feature of the process is that as soon as a firm files at the BIFR, there is an automatic stay on assets so that creditors cannot take any legal action against the firm until the filing is resolved. The initial enquiry to decide whether the firm is sick is made in a meeting that includes representatives from the company, labor unions, financial institutions, and the state and federal governments (Goswami, 1996, page 51). If the BIFR finds that the firm has not met the criteria of financial distress, the filing is dismissed. About 30% of the filings made to the BIFR are dismissed because the firms do not meet the criteria for financial distress, but it can take up to a year on average for the BIFR to determine whether a firm is to be dismissed or to be admitted into bankruptcy. The automatic stay accompanied by the long delay before the BIFR renders a decision as to whether the firm is eligible for bankruptcy may create an incentive for firms to file for bankruptcy to avoid paying creditors (Government of India, 2002).
It is widely acknowledged that the bankruptcy system has been abused by firms seeking to avoid their creditors. Quoting from a major newspaper, “The best way for Indian corporates to avoid repayment of loans to financial institutions seems to be the BIFR route,” (Indian Express, June 27, 1999). For example, in the case of Richmen Silks, the BIFR dismissed the filing noting in its ruling, “The sole motive of filing a reference…was to deny the secured creditors the opportunity to recover their dues” (The Hindu, March 18, 2001). In the case of Paam Pharmaceuticals, although the company’s creditors alleged that its balance sheet was fabricated, the BIFR admitted the firm into bankruptcy (Indian Express, April 21, 1999).
Once the BIFR validates that a filing firm is sick, an attempt to reorganize the firm is initiated. As noted, the firm need not pay any interest or repay any principal on its debt during the reorganization process, and similar to Chapter 11, the board of directors remain in control. The management may propose the initial plan to reorganize the firm. If this plan is acceptable to all creditors, the plan is sanctioned under SICA 17(2). If creditors do not agree with the management’s plan, and if the BIFR believes that it is in the public interest to reorganize the firm, the BIFR appoints an Operating Agency (OA) to examine the turnaround possibility.
The OA consults with other creditors while preparing a reorganization plan to be submitted to the BIFR. The proposal for reorganization is presented to all the stakeholders of the firm and the proposal must be accepted by all parties making concessions in order to be approved (Section 19(2) of SICA). If the proposal is accepted, the plan is approved under Section 18(4). If this proposal is not accepted by all parties making concessions, the BIFR may recommend liquidation of the firm.3 To do this, the BIFR may either forward its opinion to the civil courts under Section 20(1), or it may proceed with the sale of assets and remit the proceeds to the High Court for distribution under Section 20(4). Note that following the BIFR’s order to liquidate, the actual liquidations are carried out in the civil courts, which typically involve even longer delays. Panagariya (2008) notes that 48% of the cases take more than 10 years to complete and 10 percent take about 25 years (page 293), mainly because firms can appeal liquidation decisions. Hence, creditors are unlikely to recover their assets in a timely fashion in a liquidation given the further delays in the civil courts that carry out the liquidation.
The commonly cited reasons for the delays at the BIFR include the high workload (the BIFR reviews cases for the whole economy with a small staff), delaying tactics used by the firm such as not providing financial records, and a lack of cooperation from creditors when asked to
3
There are no provisions under SICA to divide creditors into classes or to force them to accept a plan (even if the majority of creditors agree upon a plan), which is a contributing factor in the long delays.
make concessions (Kang and Nayar, 2003-04, Panagariya, 2008). Note also that if any party (creditors, debtor, labor unions, state and federal governments) is not satisfied with the decision of the BIFR, they can appeal to the appellate court, creating further delays.
2.1.2 Recovery of Debts due to Banks and Financial Institutions Act, 1993.
This legislation was enacted to strengthen the ability of creditors to recover debts. Under this act, banks and financial institutions can recover outstanding debts greater than Rs. 1 million by filing a petition before a specialized court known as a Debt Recovery Tribunal (DRT).4 The official policy noted that: “Recovery of dues due to banks and financial institutions is not given any priority by the civil courts. The banks and financial institutions like any other litigants have to go through a process of pursuing the cases for recovery through civil courts for unduly long periods” (Government of India, 2000). The DRTs were introduced in a staggered way across the different Indian states after 1993, and they follow a streamlined procedure laid out by the Indian government intended to hasten the process of appraising and validating debt claims. A lender’s attempt to recover outstanding debts through a DRT, however, does not prevent a firm from seeking bankruptcy protection from the BIFR. Since the DRTs were intended to speed up the debt recovery process and improve creditor rights, we use their introduction across the different Indian states in different years to capture a change in creditor rights.5
2.2 Banking Sector Reforms
Prior to 1991, India’s economy and financial markets were heavily regulated. A complicated regulatory regime required firms to obtain licenses for most economic activities, and many industries were reserved for the public sector, including much of the financial system. Bank
4
According to the March 12, 2010 exchange rate, 1 USD is equal to Rs.45.5 5
nationalizations in 1969 and 1980 increased the public sector share of deposits to over 80%, and branch licensing was rigidly controlled. Primarily focused on financing government spending and serving priority sectors such as agriculture, India’s public banks lacked proper lending incentives and exhibited a high number of non-performing loans. An editorial in a leading economics weekly noted: “The Indian financial sector is dominated by the government-owned banks and financial institutions. Businessmen have exploited this situation to build their family empires with borrowed money even as they kept lenders at bay,” (Economics and Political Weekly, July 13, 2002).
Following a balance of payments crisis in 1991, a number of structural reforms were implemented that greatly deregulated many economic activities in India. In November 1991, a broad financial reform agenda was established in India by the Committee on the Financial System (CFS). One of the committee’s recommendations was to introduce greater competition into the banking sector. The reforms also deregulated deposit rates, reduced requirements that banks invest in government securities, and eliminated regulatory barriers protecting government banks from competition in the market for long-term loans.
Another key recommendation of the CFS was to allow entry by private domestic and foreign banks. It was argued that private bank entry would improve the competitive efficiency and productivity of the Indian banking system.6 Describing the inefficiency of the banking sector in recovering loans, an editorial noted: “The Indian financial sector is dominated by the government-owned banks and financial institutions. Businessmen have exploited this situation to build their family empires with borrowed money even as they kept lenders at bay,” (Economics and Political Weekly Editorial, July 13, 2002).
New private bank entry guidelines were established in 1993, and in April 1994, the Indian government allowed foreign bank entry under the WTO General Agreement on Trades in
6
Services. While there were no restrictions on where foreign banks could establish new branches, their expansion was by de novo branches only as foreign banks were not allowed to own controlling stakes in domestic banks.
The banking sector reforms led to an increase in domestic private and foreign bank entry. On March 31, 1994 there were 24 foreign banks with 156 branches in India. In the eight years following the acceptance of GATS, the total number of foreign banks increased to 41 with 212 branches as of March 2002. Private domestic banking exhibited an even larger increase. Twelve new private banks and 1,700 new branches were added between 1993 and 2004. Increase in banking sector competition due to private and foreign bank entry appears to have led to significant improvements in the efficiency of government banks (Bhaumik and Dimova, 2006). An editorial in the Economic and Political Weekly noted: “Financial sector reforms…forced banks to confront the quality of their loans and wake up to the reality of huge and rapidly growing NPAs [non-performing assets],” (EPW Editorial, July 13, 2002).
3. Data
The data on bank entry are published by India’s central bank, the Reserve Bank of India (RBI). These quarterly data provide the outstanding deposits and loans and the number of bank branches in each district by bank ownership group between the years 1991 and 2004. Bank ownership categories include state and nationalized (government) banks, private domestic, foreign, and regional rural banks. Using data from the fourth quarter of each year, we construct several measures of banking sector characteristics at the district and year level. First, Total Banks/Population is the ratio of the number of bank branches in that district and year to district-level population (in millions), which is obtained from India’s 2001 census. Second, we use 1-HHI, where HHI is the Herfindahl Index of deposit shares by bank ownership. Because deposits are not available at the branch level, we use district-level deposit shares of the four main types of
banks – government, domestic private, foreign, and rural – to calculate the HHI for each district and year. Deposit shares are defined as the ratio of total deposits held by each ownership group in a district to aggregate bank deposits in that district. By construction, 1-HHI will vary between 0 and 1, with higher levels indicating more competition. To distinguish the impact of bank entry by bank type, we use Private Bank % of Deposits, which measures the share of total deposits in that district held by domestic private banks; State Bank % of Deposits, which is the share of deposits held by government banks; and Foreign Bank % of Deposits, which is the share of deposits held by foreign banks in each district and year.
From the summary statistics reported in Table 1 we note that on average there are 67 bank branches per million people across all Indian districts during our sample period. Government banks dominate the banking sector, accounting for an average of 82% of all deposits, domestic privately-owned banks account for about 6%, and foreign banks account for 0.15% of total deposits over this period. The remaining share is held by rural banks, which we ignore as they are government sponsored banks that finance small, agricultural loans.
In Table 2 we compare average banking sector characteristics at the district level in 1991, when the reforms were initiated, and at the end of the sample in 2004. Bank entry deregulation led to a substantial increase in the deposit share at the district level of private domestic banks from an average of 4% in 1991 to 18% in 2004, while the deposit share of government banks decreased from 86% to 74% over the same period. While the overall presence of foreign banks increased following deregulation, their relative market share did not increase since their entry was limited to fewer branches.7
The bankruptcy data for our study is collected from the Board for Industrial and Financial Reconstruction (BIFR) in New Delhi, and includes the population of bankruptcy filings at the
7
Because of limits on the number of new foreign bank branches that were allowed under India’s agreement with the WTO, foreign banks entered just 8 new districts between 1991 and 2002, and 9 additional districts between 2002 and 2004.
BIFR since 1991.Of the 4,212 firms that filed for bankruptcy during this period, 842 firms were still waiting to be either admitted into the bankruptcy process or to be dismissed if they were found to not meet the criteria for financial distress; 1,327 firms were found to not meet the criteria for financial distress and were dismissed; and 1,707 firms were determined to be “sick” and were admitted into the bankruptcy process. Of the 1,707 firms admitted, 992 firms were approved for liquidation, and the remaining 715 were either approved for restructuring or were still undergoing negotiations with lenders for restructuring.
We use the year that a firm files for bankruptcy and the district-level location of its head office to construct the bankruptcy outcome variables for each district and year. To analyze the relationship between banking sector competition and the number of bankruptcy filings, we use total corporate filings for bankruptcy in a given district and year per million persons (Total Filings/Population). We also disaggregate the filings into a number of categories: filings that are dismissed for not meeting the criteria of financial distress (Dismissed Filings/Population); filings pending determination of financial distress (Pending Filings/Population); and, filings where the firm has been validated as financially distressed (Sick Filings/Population). The “sick” filings are further disaggregated into those where the firm and lenders are negotiating or have negotiated a restructuring agreement (Workouts/Population), and firms that are ordered to be liquidated by the bankruptcy court (Liquidations/Population). To examine the relationship between bank entry and bankruptcy delays, we define the average number of days taken for a successful restructuring decision (Average Duration of Workouts); average number of days taken for a liquidation order (Average Duration of Liquidations); and, the average number of days taken for either a workout or liquidation decision to be rendered by the BIFR (Average Duration of Workouts and Liquidations).
From the descriptive statistics reported in Table 3 we observe that in a given district and year there are 0.16 bankruptcy filings on average per million people. Of the firms that file for
bankruptcy, about 50% are determined to be financially distressed and are admitted to the BIFR for bankruptcy proceedings. Another 31% of filings are dismissed for not meeting the criteria for financial distress, and 19% await a decision from BIFR about whether they meet the criteria for financial distress. Among firms that meet the criteria of financial distress and are admitted into the BIFR for bankruptcy proceedings, about one-half are ordered by the court to be restructured and the rest to be liquidated. Considering average delays in the bankruptcy process, we note that it takes more than 4 years on average to obtain a restructuring or liquidation decision once a firm files with the BIFR. However, as noted earlier, subsequent to the BIFR’s decision, liquidations are carried out in the civil court system, which involves even longer delays up to 10 years or longer (Panagariya, 2008).
4. Empirical Specification and Results
To examine the relationship between banking sector competition and bankruptcy outcomes, we estimate the following OLS district-level panel regression with district and year fixed effects for the period 1991-2004:
(1) , . . 1 0 .t dt dt t d dt d Bank Environment X Outcome Bankruptcy =
β
+β
+ +δ
+α
+ε
where Bankruptcy Outcome is the bankruptcy measure of interest for district d, in year t, and Bank Environment captures local banking sector competition, entry, and ownership in that district and year. We include district fixed effects, αd, to control for time-invariant district characteristics that may explain the incidence and outcome of bankruptcies in that district, and we include year fixed effects,δt , to control for any country-level changes in the bankruptcy process.8 Other
time-
8
Two related reforms undertaken during this period are the RDDBI Act introducing the debt recovery tribunals beginning in 1993 (which we explore below) and the SARFAESI Act of 2002. Since SARFAESI was implemented at the national level, any effect it might have on overall bankruptcies at the BIFR will be captured by the time dummies. Our findings below are also robust to dropping post-2001 bankruptcies.
varying controls are included in Xdt, and the standard errors are clustered at the district-level. We use a variety of measures to control for other factors that may also affect the incidence and outcomes of bankruptcy, To control for economic growth we use the state-level GDP in each year and state, Log(GDP of State). Note that district-level GDP figures are not available in India. As a proxy for district-level growth, we include the number of bank branches per million people, Total Banks/Population, which measures growth of the financial sector in the district. All subsequent results are also robust to using Log(Total Bank Credit) as an alternative proxy for district-level growth.
4.1 Banking competition and bankruptcy outcomes
In Table 4, we describe the overall impact of an increase in banking sector competition on bankruptcy outcomes using the Herfindahl index of deposits, 1-HHI. The results reported in column (1) suggest that the total number of bankruptcy filings in a district increase significantly following an increase in banking competition in that district. This effect is also economically large. A one-standard deviation increase in 1-HHI, capturing an increase in banking sector competition, is associated with an increase of 0.176 filings per million people, where the average number of filings is 0.160 filings per million people. This effect is robust to controlling for state-level growth, total bank entry at the district state-level, and district and year fixed effects. Total bank entry is positively correlated with bankruptcy filings, providing additional evidence that bank entry into a district is related to bankruptcy decisions in that district.
The results reported in columns 2-4 of Table 4 show that an increase in banking sector competition is associated with an increase in the number of firms dismissed by the BIFR because they are not financially distressed (column 2), but there is no change in the number of financially distressed firms (column 4). We also note that a large number of the filings are still pending determination of financial distress (column 3). The automatic stay on assets accompanied with the
long delay before the BIFR determines whether a firm is to be admitted can create an incentive for firms to strategically file for bankruptcy to avoid paying creditors (Government of India 2002; Panagariya, 2008). Hence, the increase in dismissed filings without an increase in financially distressed firms suggest that an increase in competition in the banking sector is associated with increased monitoring of borrowers, leading more firms to seek protection from creditors by filing for bankruptcy and obtaining a stay on all creditor claims.
Of the firms that are declared sick, an increase in bank competition is associated with a decrease in the number of liquidations (column 5), and correspondingly an increase in the number of restructuring decisions or “workouts” (column 6).9 Since liquidation decisions are highly contested and appealed over several years in the courts (Panagariya, 2008), more competition among banks may create an incentive for creditors to make more concessions in restructuring negotiations and move away from lengthy liquidations.
Despite the increase in filings, an increase in banking sector competition is associated with a significant decrease in the average duration time for workouts and liquidations (column 7). A one-standard deviation increase in 1-HHI leads to a decrease of 425 days (14 months) in the average time taken to obtain a restructuring or liquidation decision from the bankruptcy court. This represents a sizable drop relative to the average bankruptcy duration of 1,422 days (3.8 years) in India. We noted earlier that one of the reasons cited for the delays is the lack of cooperation from creditors asked to make concessions in restructuring. So an increase in creditor incentives to monitor borrowers due to an increase in the competitiveness of the banking sector may lead creditors to make more concessions and reduce delays.
9
By construction, the number of sick firms matches the sum of workouts and liquidations. After a firm is declared sick, firms and lenders must either agree to enter into negotiations regarding a workout, or the lenders can make a request to have the firm liquidated.
4.2 Bank ownership and bankruptcy outcomes
We also investigate the impact of bank entry in a district on local corporate bankruptcy outcomes based on the ownership of banks. In Table 5, we find that an increase in the share of deposits held by domestic private banks is associated with an increase in bankruptcy filings (column 2), but entry by foreign banks is not (column 3). For example, a one standard deviation increase in deposits held by private banks is associated with a standard deviation increase in bankruptcy filings per million persons. Mirroring the private bank estimates, an increase in government-owned banks’ share of deposits is associated with a reduction in bankruptcy filings.10 Consistent with Shleifer and Vishny’s (1998) argument that government ownership leads to soft budget constraints and lower economic efficiency, the results complement the findings of La Porta et al. (2002) and Barth, et al. (2004) who show that government ownership is associated with less efficient financial systems, and more non-performing loans. Since private banks account for a small fraction of loans and deposits relative to government banks, our results reflect not just the practices of new private banks, but also an increase in competitive pressures that affect the lending practices of government-owned and other incumbent banks.
Domestic private banks may have more influence on bankruptcy outcomes relative to foreign banks for a number of reasons. First, foreign banks are present in fewer regions compared to domestic banks. Second, foreign banks may be more likely to lend to firms with lower delinquency rates, so that the need to monitor these firms is lower. Third, foreign banks may be less willing to utilize the bankruptcy courts because they are at a disadvantage relative to domestic banks in successfully navigating the system in pursuit of delinquent firms. We provide evidence in support of the last argument in Section 5 below where we consider the role of creditor rights.
10
Only 28 of the 565 districts experience an increase in the percent of deposits held by government banks. Since changes in the deposit share of government banks are driven by changes in the share of private banks, this coefficient will generally mirror the private bank results.
In unreported estimates, we also find that private bank entry is associated with an increase in dismissed filings rather than an increase in financially distressed firms, which suggests that the increase in filings is a response to greater creditor monitoring.
4.3 Firm ownership and bankruptcy outcomes
Bankruptcy outcomes may also vary based on the ownership of filing firms. To investigate, we separate the sample into private and government-owned firms filing for bankruptcy. From the results reported in column 2 of Table 6, we note that the share of deposits held by private banks is positively related to the number of filings by private firms. The magnitude of the effect is similar to that of the full sample reported in Table 5. However, an increase in the share of deposits held by private banks is negatively related to the number of filings by government-owned firms (column 5). Government bank estimates largely mirror those of the private banks, while the share of deposits held by foreign banks is not significantly related to bankruptcy filings. The evidence also suggests that the presence of government banks may reduce financial constraints for government-owned firms, reducing bankruptcy filings by these firms. The differential impact of private bank entry on government firms suggests that private banks may be limited in their ability to pursue politically connected government-owned firms, with access to soft budget constraints.11
4.4 Bank entry and workouts and liquidations
Firms that are found to be financially distressed by the BIFR must either reach an agreement with creditors to restructure the firm’s liabilities, or be liquidated, a process which is
11
This finding may also reflect a lower willingness among private banks to finance government firms, thus reducing the number of future delinquencies by these firms. However, this cannot explain the entire drop since we would then observe an initial increase in government bankruptcy filings as private banks restrict lending to these firms, which we do not.
carried out in the Indian civil court system subsequent to the BIFR’s ruling. In Table 7 we examine the relationship between bank entry and the frequency of restructurings and liquidations.
The results show that private bank entry is associated with a shift away from liquidation orders in favor of restructuring decisions rendered by the bankruptcy court. As shown in Table 7, column 2, a one percentage point increase in the share of deposits held by private banks is associated with an additional 0.007 workouts per million persons (average workouts for the sample are 0.037 per million persons). Since the number of sick firms does not increase with private bank entry, the increase in workouts must come from a decrease in liquidations. This is in fact what we observe in column 5 of Table 7. There is no discernible effect of foreign bank entry on the relative use of workouts and liquidations (columns 3 and 6), and as expected, the estimates for government banks largely mirror those of the private banks (columns 1 and 4).
These results suggest that an increase in competitive pressures following the entry of private banks may lead creditors to make more concessions to reach an agreement on restructuring proposals. Restructuring proposals might allow for quicker recovery of assets relative to liquidation proceedings, which are carried out in the Indian civil court system following the BIFR’s ruling to liquidate. Asnoted by Panagariya (2008), the liquidation process can take a decade or longer in the civil courts.
In unreported results, we find that the shift away from liquidation towards more workouts is driven by the filings of private firms and not government firms. Restricting the sample to bankruptcy filings by government firms, we find that both workouts and liquidations decline with an increase in the share of deposits held in private banks. Restricting the sample to only private firm filings, we observe a drop in liquidations and a corresponding increase in workouts with greater private bank entry, similar to the results for the full sample described above.
4.5 Bank entry and the duration of bankruptcy outcomes
The observed increase in bankruptcy filings following private bank entry may increase the burden on the bankruptcy process, leading to more delays. To investigate, we consider the impact of bank entry on the average number of days taken for the bankruptcy court to render a decision to sanction a restructuring scheme or a liquidation proposal.
The results reported in Table 8 show that despite the increase in bankruptcy filings, private bank entry is significantly negatively related to average duration of bankruptcy (column 2). For example, a one standard deviation increase in the share of deposits held by private banks is associated with an average duration that is 422 days shorter. Foreign bank entry is also associated with a drop in average duration, but the coefficient is not statistically significant at conventional levels (Table 8, column 3).
The drop in the average duration of a workout or liquidation decision is not just driven by a shift away from liquidations. This can be seen in columns 5 and 8 of Table 8 where we consider average duration for workouts and liquidations separately. Private bank entry is negatively related to duration for both types of outcomes, and the magnitudes are also economically significant. A one standard deviation increase in the deposit shares of private banks is associated with an average decrease of 609 days (20 months) in the duration of workouts, and a decrease of 414 days (13 months) for liquidations. One of the commonly cited reasons for the long delays at the BIFR is that creditors are slow to respond to requests for making concessions in workouts (Kang and Nayar, 2003-04; Panagariya, 2009). The larger decrease in the duration of a workout decision suggests that making concessions in workouts may be one way in which private banks attempt to recover assets more quickly. Foreign bank entry in contrast is associated with an increase in restructuring delays, which suggests that foreign banks may be relative disadvantaged in navigating the bankruptcy process.
states, as indicated by the statistically significant negative coefficient of Log(State GDP). This may reflect an improvement in firms’ ability to repay or a greater willingness of lenders to renegotiate in a growing economy. The relationship between Log(State GDP) and the average duration of liquidations is also negative but not statistically significant.
5. Creditor Rights and Bankruptcy
Starting in 1993, the Indian government introduced specialized courts, the Debt Recovery Tribunals (DRTs), in a staggered way across the different Indian states to speed up the debt recovery process. We use the introduction of these tribunals to capture a change in creditor rights. While the courts may have jurisdiction over neighboring states, we consider whether a particular state has a DRT in order to capture the fact that distance from the court may affect the rights of creditors. Specifically, we define the variable DRT in State to be equal to one if the government has set up a debt recovery tribunal in that state and year and all subsequent years, and equal to zero otherwise.
Once a firm files with the BIFR, lenders cannot use the debt tribunal to recover their assets. Therefore, an increase in creditor rights may increase bankruptcy filings as more firms file with the BIFR to avoid the recovery of assets through the courts. We would also expect that creditor incentives, as captured by a change in banking sector competition, would matter more when creditor rights, and therefore enforcement, are stronger. We examine the effect of a change in creditor rights in Table 9. Note that here we cluster the error term in the specifications at the state level instead of at the district level as in the rest of the paper, so as not to overestimate the impact of the presence of a DRT at the state level.
We find that stronger creditor rights (captured by having a DRT present in the firm’s state) is not directly related to a change in bankruptcy filings, but there is an increase in filings associated with private bank entry in districts with stronger creditor rights (Table 9, column 3).
Once we account for creditor rights, foreign bank entry is associated with an average drop in bankruptcy filings when creditor rights are weak, but an increase in filings when they are strong (column 4), indicating that creditor rights may be particularly important for foreign banks. These results further corroborate our interpretation that creditor incentives to monitor borrowers can affect bankruptcy outcomes.
In unreported results, we find that the increase in filings in districts with both stronger creditor rights and more private bank entry is driven by an increase in either dismissed or still pending filings and not by an increase in distressed firms, which suggests that these firms file to escape increased creditor scrutiny. We also find that foreign bank entry in districts with stronger creditor rights is associated with an increase in the number of workout decisions but not the number of liquidation decisions made by the bankruptcy court.
6. Interpreting the results
In this section we discuss the robustness of our results to potential identification issues, and the alternative channels by which bank entry may affect corporate bankruptcy outcomes.
6.1 Identifying the impact of bank entry
A potential identification concern is that banks’ decisions to enter a district are likely to be related to various unobservable characteristics of that district. To the extent that these factors are also related to bankruptcy outcomes, the specification may suffer from an omitted variable bias. However, the potential source of omitted variables in our estimation is very specific. Time-invariant differences across districts that are correlated with both bank entry and bankruptcy outcomes will be captured by the district-level fixed effects, and country-level trends in both bank entry and bankruptcy outcomes will be absorbed by the inclusion of year fixed effects. The source of omitted variables is thus limited to district-level characteristics that are related to both banking
entry and differential trends in bankruptcy outcomes within districts over time.
One such omitted variable may be that private banks are more likely to enter districts with greater future growth potential. If higher future growth is also associated with greater firm exit rates in the future, this future growth may then also be related to the number of bankruptcies. In this case, our result that bankruptcies increase following private bank entry may reflect these banks’ choice to enter districts where future bankruptcies trend upward for reasons related to the districts’ higher future growth rather than to bank entry. Note however that if private banks entered districts that were already growing faster and had a higher level of bankruptcies, this would be captured by the district-level fixed effects. For an omitted variable bias to arise, it must be the case that districts with more bank entry are likely to experience greater future growth in the number of bankruptcies.
Our findings are robust to using various controls to capture differential growth rates across districts, as reported in Table 10. First, we find that using the log of total loans at the district level to capture district-level growth and financial development does not affect our results (Table 10, column 1). The increase in bankruptcy filings is also robust to allowing districts to trend differently based on their level of urbanization (column 2).12 This suggests that the relation between bank entry and bankruptcy outcomes is not driven by a concentration of bank entry in India’s growing, urban districts.13 In unreported results we also find that our results are robust to adding literacy-year interactions, which may be another measure of which areas are more likely experience greater growth. The findings are also robust to using state-year fixed effects to
non- 12
Our measure of urbanization is an indicator that is equal to one if a district’s share of citizens located in urban areas is in the top quartile according to the 2001 Indian Census. Since the census data is only available for 2001, we interact this indicator with year-dummies to control for differential time trends. Our results are similar if we define urbanization more broadly (above median) or more narrowly (top decile). 13
Rising real estate values might affect the incentives of lenders to liquidate firms and recover underlying assets. This result suggests that changes in bankruptcy outcomes are unlikely to be driven by new bank entry being concentrated in districts with rising real estate prices, which tend to increase faster in urban areas.
parametrically capture differential trends in bankruptcy filings across India’s states (column 3). Lastly, as described in Table 11 below, we find that controlling for output growth in each district does not affect our findings.
The main results also suggest that banks’ decision to enter high-growth areas is unlikely to explain the findings. In particular, if the increase in bankruptcy filings reflected new firm entry driving out unviable firms, we would observe an increase in the number of financially distressed firms, which we do not. It is also unclear why greater growth at the district level leading to more firm exits would be correlated with more workouts, fewer liquidations, and a decrease in the average duration for workouts and liquidations. Lastly, our result showing that the increase in bankruptcy filings following bank entry is even greater in states with stronger creditor rights cannot be explained by higher growth districts.
Another potential omitted variable bias might arise if bank entry is more likely to occur in districts where incumbent banks are captured by politically connected firms and are burdened by underperforming political loans. These districts may be a target for new banks if there is a large unsatisfied demand for credit in the region. But, these districts may also experience more future bankruptcies, irrespective of bank entry, if politically-connected, underperforming borrowers of incumbent banks are more likely to end up in bankruptcy.
Our findings are robust to adding proxies for the presence of political loans in a district, which we measure using the share of borrowings and the share of sales accounted for by government-owned firms in each district-year. Specifically, we calculate these measures using information on firms covered in Prowess, a firm-level financial dataset covering nearly 80% of industrial output in India.14 In Table 11 we show that private bank entry remains positively associated with increased bankruptcy filings after controlling for the presence of political loans
14
Compiled by the Centre for Monitoring Indian Economy (CMIE), Prowess is a panel of both listed and unlisted public limited companies with assets plus sales greater than 40 million Rupees (approx. $900,000), and covers between 2,000 to 6,000 firms each year from 1991-2002.
(column 1). The results are also robust to using the market share of government-owned firms in a district to control as a proxy for the presence of politically-connected firms (column 2). Lastly, as another check on more bank entry occurring in districts with higher growth rates as discussed above, we find that controlling for overall output growth at the district level with sale revenues of firms in that district, Ln(Sales), does not affect our results (column 3).
In unreported results we also investigate whether private bank entry is more likely to occur in districts with more politically motivated loans. Specifically, we look at the relationship between average private bank deposit shares at the district level in the post-reform years of 1996-2004, and the proportion of bank branches in a district that are government-owned in the pre-reform year of 1988. We find that private bank deposit shares in the post-pre-reform era are not significantly related to the share of government bank branches in that district in the pre-reform era, which suggests that private banks do not selectively choose to enter districts dominated by government banks, which typically make more politically motivated loans.
The main analysis also suggests that selective entry into districts with a disproportionate amount of political loans is not likely to explain our results. The observed decrease in government firm bankruptcies is not consistent with the argument that bankruptcies are driven by political loans. Greater presence of political loans in a district driving bank entry also cannot easily explain why bank entry would be correlated with more workouts, less liquidations, or reduced average duration in that district. Political loans also cannot explain why bankruptcy filings increase following bank entry in districts with stronger creditor rights.
Another issue is whether bank entry is more likely to occur in districts where the enforcement or stringency of bankruptcy requirements are increasing at a greater rate. Such improvements in the law or its enforcement would be directly related to changes in bankruptcy outcomes and could also influence bank entry decisions. Differential changes in bankruptcy requirements or enforcement, however, are unlikely to explain our results. As described earlier,
the BIFR was set up under the Sick Industrial Companies Act of 1985, which is a federal government legislation that applies to all firms in the economy. All bankruptcy rules and procedures at the BIFR, including the financial criteria for determining sickness and the procedures for obtaining a restructuring or liquidation order, are done at the national level. Moreover, the members of the BIFR court, which is located in the Indian capital of New Delhi, are typically career bureaucrats appointed by the federal government.15 This centralized decision process minimizes the chance of enforcement variation at the district level. As we describe in Table 9, our findings are also robust to controlling for a potential source of variation in creditor rights at the district level, the presence of a debt recovery tribunal.
6.2 Identifying the direction of the relationship
An alternative interpretation of our results is that the shift in bankruptcies drives banking sector entry, rather than vice versa. This issue may arise if increased bankruptcies adversely affect the health of incumbent banks by reducing their capital reserves, deposit base, and ability to meet local firms’ demand for loans. New bank entrants, which are not burdened with these underperforming legacy loans, may choose to enter these districts. Bankruptcies of older firms may also clear the way for entry by young, upstart firms, which may then attract the entry of new banks hoping to finance the new firms.
While it is difficult to fully exclude simultaneity bias, it is unclear why some of our other estimates with respect to bankruptcy outcomes and duration would also be subject to a simultaneity bias. For example, it is unclear how a shift away from liquidations towards workouts for incumbent banks might increase the entry of new banks. It is also unclear why a drop in the average duration of bankruptcy would facilitate new entry since this change in duration is unlikely to reflect any local shift in bankruptcy regulations.
15
As a robustness check we investigate whether increased bankruptcies preceded future entry by private banks in a district. In Table 12 we add lags and leads of the private bank entry measure to the base specification. If the prior estimates are driven by a change in bankruptcies affecting bank entry choices, then we would expect to find a positive correlation between current bankruptcy levels and future bank entry after controlling for contemporaneous entry (Wooldridge, 2001, page 285). In column 1 of Table 12, we add a measure for private bank entry in t+1, but do not find any evidence that future bank entry is correlated to current bankruptcies. Adding a measure for bank entry in t-1 (column 2), we find that past bank entry does predict current bankruptcies. In fact, we find that our measure for contemporaneous bank entry is primarily capturing the impact of previous bank entry going back two years (column 3).16 The lagged impact of bank entry is consistent with causality running from bank entry to bankruptcies.
6.3 Channels by which bank entry may affect bankruptcy
Our results suggest that private bank entry affects the incentive of creditors to aggressively monitor borrowers. The increase in frivolous filings following private bank entry, suggests that firms seek the protection of the automatic stay on assets in bankruptcy to avoid increased creditor scrutiny. The shift to restructurings from liquidations, which can take even longer to resolve, and the decrease in delays in the bankruptcy process also indicate that a change in creditor incentives to monitor borrowers may affect the efficiency of the bankruptcy process. The increase in bankruptcies associated with bank entry when creditor rights are stronger is also consistent with bank entry being related to a shift in creditors’ incentives.
However, a change in creditor incentives may not be the only channel by which bank entry may affect bankruptcy outcomes. A change in the supply of credit associated with bank entry may also be related to bankruptcy outcomes. This may occur for example if the amount
16
firms are able to borrow changes, or if private and foreign banks lend to different types of firms following their entry into a market.
Our results, however, do not appear to be driven by changes in the supply of credit. If bank entry is associated with easier access to credit, we should observe an immediate decrease in bankruptcy filings following entry, while we find the opposite. If improved access to credit instead fostered more product market competition, then we would expect to observe an increase in filings by financially distressed firms as weaker firms are pushed out by the entry of new firms. However as noted in Table 4, the number of financially distressed firms does not increase following bank entry. Our results are also robust to controlling for the aggregate availability of credit measured by total bank loans at the district level. Lastly, it is not clear why shifts in the supply of credit or product market competition would affect the results on changes in bankruptcy outcomes and average duration.
Entry by private banks may also affect bankruptcy outcomes by changing the pool of borrowers, and thereby the type of bankrupt firms.17 For example, private banks may be more likely to extend and monitor loans to better firms because they have a higher chance of repayment or more collateral to pledge. But, if better firms are funded by entering private banks and everyone else continues to receive credit from incumbent banks then we should observe a decrease in filings, contrary to our results. Alternatively, if a shift in credit to better firms causes worse firms to get less credit, then we should observe an increase in financially distressed firms if filings are driven by bad firm exits, which we do not. It is also not clear why a shift in credit to better firms would result in an increase in dismissed filings, or why these changes in the supply of credit would be related to creditor rights. Lastly, inconsistent with this channel, we do not find any evidence that the type of firms filing for bankruptcy changes following private bank entry.
17
For example, bank entry might reduce credit access for opaque firms (Petersen and Rajan, 1995) and increase credit access for riskier firms (Dell’Arricia and Marquez, 2009).
Specifically, we conduct two tests to investigate whether bank entry affects the characteristics of bankrupt firms. Specifically we examine whether bank entry affects the size and financial characteristics of bankrupt firms, and second we control for these characteristics. The data on firm characteristics is restricted only to firms that file for bankruptcy, which will reduce the sample size as bankrupt firms are not located in all Indian districts. In Table 13, Panel A we examine the effect of private bank entry on the characteristics of bankrupt firms, and do not find a significant correlation between entry by government, private, or foreign banks and the financial characteristics and workforce size of firms filings for bankruptcy. Hence, it appears that private bank entry does not change the pool of bankrupt firms. Second, in Panel B of Table 13, we examine the relationship between private bank entry and bankruptcy outcomes, controlling for the characteristics of bankrupt firms in that district. As reported, the results are similar to those obtained previously, although some effects are less statistically significant because of the lower sample size.
7. Concluding remarks
We investigate whether entry in the banking sector is related to changes in the bankruptcy process based on the hypothesis that increased competition among banks may change creditor incentives towards monitoring or exerting pressure on defaulting borrowers. Our results are consistent with this argument.
We find that on average, more firms file for bankruptcy to avoid heightened creditor scrutiny following bank entry, rather than due to financial distress. The results also show that bank entry is associated with a shift from liquidations to restructuring, suggesting that one channel by which banks may affect the bankruptcy process is to make more concessions in order to more quickly reach a restructuring agreement. Lastly, despite the increase in bankruptcy filings, bank entry is associated with a significant decrease in delays in the bankruptcy process.
Our results also show that the ownership of creditors and firms matter. The increase in bankruptcy filings and decrease in delays is driven by the entry of private domestic banks. Private bank entry is also associated with a shift from liquidations to restructurings among private firms, which may reflect a stronger incentive to quickly resolve the bankruptcy process and recover some assets. However, private banks appear less willing or able to pursue delinquent government firms. Interestingly, the entry of foreign banks is largely unrelated to bankruptcy filings, which suggests that foreign lenders may face relatively greater hurdles in navigating the local bankruptcy system.
We show that strengthening creditor rights in combination with private and foreign bank entry, leads to an increase in filings. Creditor rights are particularly important for foreign banks. While foreign bank entry has no relation to either workouts or liquidations when creditor rights are weak, it is associated with decrease in liquidations and an increase in workouts in districts with stronger rights.
Overall, our evidence suggests that banking sector competition and lenders’ incentives play an important role – in addition to bankruptcy regulations and creditor rights – in bankruptcy outcomes. Lenders without a strong incentive to aggressively monitor loans, such as government banks and banks that face relatively little competition in their local market, may contribute to the inefficiency of some bankruptcy systems. An important implication of these findings is that bankruptcy reforms that focus on changes in the law should also take into account local financial market factors such as the competitiveness of the banking sector.
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