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Distance Constraints: The Limits of Foreign Lending in Poor Economies

By Atif Mian

Abstract

Do foreign banks shy away from relationship loans requiring close monitoring and soft information in emerging economies? The difficulty in answering this question lies in separating distance constraints, i.e. constraints faced by foreign banks due to control from long distances, from traditional constraints (the usual agency costs), and borrower fundamentals. This paper separates the three by exploiting a unique panel data set containing detailed loan-level information on the universe of all 79,323 private bank loans in Pakistan. The results indicate that distance constraints significantly prevent foreign banks from lending to “informationally difficult ” yet fundamentally sound clients requiring relational contracting. Consistent with this notion, I also find that foreign banks are less likely to bilaterally renegotiate (they litigate more), and are considerably less successful at recovering defaults. A number of independent tests show that neither traditional constraints nor fundamentals are able to explain these findings. Graduate School of Business, University of Chicago

Year: 2011
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