Riots that resulted in 10 to 1,000 deaths and more in their hometowns ultimately influenced lending decisions among hundreds of loan managers in India – and the effect lasted for decades, finds a new study involving a researcher at the Olin Business School at the University of Washington at St.. Louis. Research shows that ethnic rifts in a country can create crevices on the path to economic progress.
These are the conclusions of Janis Skrastins, an assistant professor of finance at Olin, and three other researchers, who analyzed the lending decisions of approximately 1,800 Hindu loan managers at a large Indian public sector bank.
More than 250 of these loan managers had experienced deadly Hindu-Muslim riots in their hometowns as children. Later, as adult men, these loan managers preferred to lend to Hindu borrowers over Muslim borrowers.
“The most important point to remember is that your experiences of ethnic conflict in early childhood can have lasting effects,” Skrastins said. And the experiences “may in fact lead to a misallocation of resources, even in the longer term”.
The paper, “Experience of community conflicts and intergroup loans”, provides microeconomic evidence on the link between intergroup frictions and economic transactions. It is to appear in the Journal of Political Economy.
Muslim borrowers less likely to default
The favoritism of loan managers persisted even though loans they extended to Muslims were less likely to default, research has shown.
“What’s very, very important is that the money or profit that agents expect to make on a Muslim borrower is going to be higher than on a Hindu,” Skrastins said.
“So this means that they are just giving money as a favor to some members of their own group” and creating a disadvantage for another.
The researchers also found that the biases of loan managers persisted throughout their careers, suggesting that “the economic costs of ethnic conflict are long-lasting and can span generations,” Skrastins said.
The article documents the lifelong consequences of personal experiences of racial or ethnic division in childhood, rather than short-term increases in favoritism within the group as a result of current events. The authors say that to their knowledge, this is the first research on the subject.
Seven-year loan decisions
Skrastins, Raymond Fisman of Boston University, and Arkodipta Sarkar and Vikrant Vig, both of London Business School, analyzed the loan decisions of loan managers from 1999 to 2006.
In tandem, they used a database of Hindu-Muslim riots from 1950 to 1995, as well as the year and city of birth of each credit manager. With this information, they could infer whether ethnic riots broke out in a loan officer’s hometown as a child.
All the men in the sample were born after 1950 and joined the bank no later than 1995.
Researchers measured riot exposure based on riot deaths in the hometowns of loan managers from the year they were born until the time they joined the bank. Typically, new loan managers at the bank are in their early twenties. Since the bank prohibits any credit manager from working in their hometown, they necessarily leave their place of birth when they join the bank.
Since the bank requires loan managers and borrowers to indicate their religion, the researchers also had access to this information.
In their main results – which used local riot deaths of 10 or more people to define “riot exposure” – they found this: borrowers.
They also found that the presence of a riot-exposed loan manager was associated with a 2.5 percentage point increase in defaults by Hindu borrowers compared to Muslim borrowers.
The researchers also looked at loan decisions based on when the loan manager was first exposed to Hindu-Muslim violence. Exposure to riots before the age of 10 was “the most important determinant of subsequent loan decisions,” they found.
In their final analysis, the researchers looked at the decisions of loan managers related to the 2002 Gujarat riots, which killed more than 1,000.
They found that loans to Muslims fell by 8 percentage points with the arrival of a branch manager who was stationed in Gujarat at the time of the riots.
Against the grain of themselves
In some ways, loan managers are hurting their business by avoiding Muslim borrowers.
Indian state bank loan managers have an incentive to perform well, the researchers noted. Some rewards are promotions to higher ranks with higher pay – or better publications. Loan managers can be sent to places with better benefits such as better schools, bigger homes, use of a car, or control of a larger portfolio.
If a credit manager performs poorly, he risks being sent to places with weak infrastructure and lousy schools. Basically, when a loan officer plays favorites in loans that worsen their repayment rates, they get hurt, the researchers said.