In a recent short article in Economics Letters, co-authored with Simon Deakin, Law professor at the University of Cambridge, and Gregory James, Lecturer in Economics at Loughborough University, we utilise a new longitudinal dataset to show that strengthening creditor rights in India during the 1990's and 2000's led to an increase in financial development.
The creditor protection index that we use has been developed by Professor Deakin's team of lawyers at Cambridge. It draws on a wider range of legal materials and a more finely-grained approach to coding than earlier studies by La Porta and co-authors. Specifically, three sub-indices are coded, pertaining to 'debtor control', 'creditor contracts' and 'insolvency law'. Each of the sub-indices contains information on ten or more variables. Professor's Deakin's team has published the index from the mid 1970's to the present day for France, Germany, India, the UK and the US.
Econometric estimations establish that there is a long run relationship between banking sector development and creditor protection. These variables are positively related to GDP per capita, resulting in the co-evolution between the banking system and the real economy. However, when it comes to stock market capitalisation, we find that it is negatively related to banking system development, suggesting there is crowding-out between these two components of the financial system.
Further analysis using the sub-index on creditor contracts suggests that as banks become more significant lenders they press for laws that protect secured credit more effectively. Thus, the evolution of the law itself is part and parcel of the process of financial development.
The work was funded by the ESRC's World Economy and Finance Programme.
The full details of the paper are as follows:
Simon Deakin, Panicos Demetriades and Gregory James "Creditor Protection and Banking System Development in India", Economics Letters, vol. 108, 19-21, (available online at Science Direct).
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