Firm bribery and credit access: Evidence from Indian SMEs

Abstract

This study investigates the effect of paying bribes on access to credit for small, and medium enterprises (SMEs). Bribery is variously portrayed in the literature as greasing the wheel (helping) or sand in the wheel (impeding) when applying for credit leaves the issue unresolved. Using The World Bank Enterprise Surveys of SME data, an answer for India emerges using an instrumental variable probit model. SME bribery is detrimental to accessing credit and more so for firms that have been in business for many years and operating on a small scale. There are supply and demand side forces involved, culminating in differing size effect reactions. From a supply side perspective, when corruption is high, financial institutions find it harder to control borrower risk and recover loans. In that case, financial institutions reduce their lending to SMEs, which mostly belong to a high-risk category. Unlike large firms, SMEs paying bribes to grease the wheel are drawn to the informal sector, avoiding attention from officials. Where SMEs pay bribes in the formal sector it is noticed and is likely to increase the probability that other parties will also demand payments. The demand side argument regards bribes as a tax, increasing the cost of loans to the SMEs. Consequently, making significant bribes decreases these SMEs’ profitability. Less profitable SMEs may not obtain access to credit. From a policy perspective, anti-corruption measures are vital for developing SMEs. Generalising these findings to other emerging economies suggests potentially significant welfare gains.