Cultural Proximity and Loan Outcomes

We present evidence that shared codes, beliefs, ethnicity — cultural proximity — between lenders and borrowers improves the efficiency of credit allocation. We identify in-group preferential treatment using dyadic data on the religion and caste of officers and borrowers from a bank in India, and a rotation policy that induces exogenous matching between officers and borrowers. Having an in-group officer increases access to credit, reduces collateral requirements, and induces better repayment even after the in-group officer leaves. Further, proximity increases loan size dispersion in a group, and its effect diminishes with group heterogeneity and size. The results imply that cultural proximity mitigates informational problems that adversely affect lending.