The Political Economy of Rural Loan Recovery: Evidence from Bangladesh

The rural loan recovery problem in developing countries is frequently analyzed from the perspective of borrowers or financial institutions. But a frequently overlooked pro blem is that borrowers often are discouraged to repay and/or institutions are not ag gressive in loan recovery because governments intervene in rural financial markets to increase the prospects of getting re-elected. This political intervention may undermine the effectiveness of measures such as increasing real interest rates to improve loan allocation and recovery. A failure to address this political dimension in loan recovery analysis may lead to incorrect policy prescriptions. This paper provides an empirical analysis of how political interventions affect rural loan recovery in Bangladesh in the period 1980 to 1989. The results indicate that the negative effect of political interven tion in loan allocation and recovery outweighs the effect of positive real interest rates. The government in Bangladesh intervenes in rural loan allocation and recovery formal ly through policies ? interest exemptions, credit committees and interest rates ? and informally through elected local government officials and local socio-political leaders. The intensity of informal intervention is expected to increase during an election period. Five variables ?inflation rate, election years, interest exemption years, credit commit tee years and bank type ? were included in the model used to explain loan recovery. The empirical results showed that elections, inflation rates, credit committees, and bank type affect rural loan recovery negatively, while interest exemptions affect it positively.