The Microeconomic
Impact of Debt Recovery Tribunals in India
by wulan
In many developing countries and transition economies,
the quality of formal judicial institutions is poor.
Cases in court are subject to long delays.
As a result, economic agents cannot depend on courts
for the protection of their property rights,
leading to high transactions costs and other contracting
problems (Williamson 1985).
A large and growing body of theory suggests
that in such situations some welfare-improving transactions
will not be undertaken (Mookherjee 1999).
Improving the quality of formal judicial institutions
and more generally “getting the institutions right” (North 1990)
may thus allow the achievement of superior economic outcomes.
For instance, it has been shown that entrepreneurs’
confidence in a country’s institutions, including the judicial system,
predicts levels of investment and
rates of economic growth (Knack & Keefer 1995, Mauro 1995),
and that the nature of a country’s laws and the efficiency
of its judiciary can explain the concentration of share-holding
and the extent of external long-term financing
that firms receive
(Demirgüç-Kunt & Maksimovic 1998, La Porta et al. 1998).
However the literature provides very little evidence of
the micro-level mechanisms through which judicial
quality influences economic development.
This paper seeks to contribute in filling that void.
This paper investigates the effects of a
particular improvement
in the judicial institutions that process
debt recovery cases in India.
In 1993 the Indian government passed
a national act that allowed
for the establishment of Debt Recovery Tribunals
(DRTs) across India.
These tribunals are a new quasi-legal
institution set up to process
legal suits filed by banks against
defaulting borrowers.
They follow a streamlined legal procedure
that emphasizes speedy
adjudication of cases and swift
execution of the verdict.
By March 31st 2003 they had disposed claims
worth Rupees 314 billion (roughly 4 percent
of total bank credit
to the commercial sector in 2002-03) and recovered
Rupees 79 billion (Government of India 2003).
Two aspects of this reform are particularly relevant.
One, the monetary threshold for claims to be filed in a DRT
is Rupees 1 million (approximately US$ 20,000).
Two, there is variation in the
timing of tribunal establishment
in different states. Neither the monetary threshold nor
the timing of DRT placement appears to be correlated
with other factors which may influence the ability or
willingness of borrowers to repay their loans.
Therefore these two features allow a differences
in differences strategy to identify the effects of the DRTs.
The data used to implement this strategy consist of loan
level records that I collected from a large private sector
bank with a national presence.
I observe detailed information about the
contractual terms of the loans, their repaymen
schedule and actual repayment in each quarter
when an installment becomes due.
I utilize the two sources of variation described
above to examine the effect of DRTs on borrowers’
repayment behavior.
Loans that are late on repayment of more than
Rupees 1 million at the time of the legal
reform are potentially treated by DRTs.
Therefore I compare the change in the
repayment behavior of these loans after
DRTs are established, to the change in the
repayment behavior of other loans
(those with less than Rupees 1 million overdue).
The difference can be attributed to the DRTs.
To address possible concerns that other factors
may be driving these results, I conduct several
robustness checks. I control for state-level time-varying
unobservable factors
(by including state × quarter fixed effects),
and allow different time-varying unobservables
for loans above and
below the Rupees 1 million threshold.
I find robust evidence that for loans with more
than Rupees 1 million overdue, the establishment
of a tribunal increases the likelihood that an installment
is paid on time. Furthermore, this effect holds
within loans as well: for the same loan, installments
that become due after a tribunal is established are
more likely to be paid up on time than installments
that become due before.
As evidence of the economic impact of this reform,
I find further that the establishment of a DRT
leads to a change in the contractual terms of
new loans given out subsequently.
While the size of an average loan does not
change significantly, the interest rate on new
loans tends to be lower than that on comparable
older loans by 1 to 2 percentage points.
This suggests that improved repayment behavior
lowers the risk of default and allows the bank
to provide cheaper credit.
The paper is organized as follows.
Section 2 provides some background on
the factors leading to the DRT Act, and
details of the act and its implementation.
Section 3 presents a theoretical framework
to explain the phenomenon studied here.
Section 4 describes the data.
Section 5 presents the empirical strategy.
Sections 6, 7 and 8 present the empirical results.
Section 9 concludes the paper.
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The Microeconomic Impact of Debt Recovery Tribunals in India
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