Crony Lending: Thailand before the Financial Crisis

The allocation of credit by banks on 'soft' terms to friends and relatives - often termed cronyism - rather than on the basis of 'hard' market criteria in the years leading up to the Asian financial crisis of 1997-98 has been hypothesized as an important cause of the crisis. These practices had their basis in the implicit guarantees provided by the government to banks, which in turn percolated down to firms having 'crony' ties to banks as soft-budget constraints for projects of uncertain quality. Such soft-budget constraints should be reflected in preferential access to long term bank credit for firms with close ties to banks. Using pre-crisis data on borrowing patterns in Thailand we find that firms with crony ties to banks and politicians had greater access to long-term debt than firms without such ties. Surprisingly, we find that a broad range of standard firm characteristics suggested as important factors by the literature on firm finance play a much less significant role in explaining the allocation of long term bank credit. Consequently, it is difficult to avoid the interpretation that 'cronyism' was by far the main driver of pre-crisis lending patterns.