How Law Affects Lending

The paper explores how legal change affects lending behavior in twelve transition economies of Central and Eastern Europe. In contrast to previous studies, we use bank level data rather than aggregate data, which allow us to control for country level heterogeneity and to analyze the effect of legal change on different types of lenders. Using differences-in-differences methodology to analyze the within country variation of changes in creditor rights protection, we find that lending volume increases subsequent to legal change. Further, we find that Collateral law matters more for development of financial markets as compared to Bankruptcy law. We also find that new entrants respond more strongly to legal change than do incumbents. In particular, foreign owned banks extend their lending volume substantially more than do domestic banks, be they private or state owned. The same holds when we use foreign green field banks as proxies for new entrants. These results are robust after controlling for a wide variety of possibilities