Bank Branch Expansions and Capital Investment by Credit Constrained Firms

Abstract

Can financial deepening affect capital investment by credit constrained firms? We examine this by exploiting a nationwide bank expansion policy in India that incentivized banks to open branches in ``underbanked'' districts -- districts where the ex-ante bank branch density was less than the national average. Using a 10 year establishment-level panel and extending a regression discontinuity design, we find substantial increases in capital expenditures and credit growth by manufacturing establishments in underbanked districts following the policy intervention. The increase in capital spending and credit growth is driven by establishments most likely to face binding credit constraints -- namely small and young establishments, and establishments not owned by publicly listed corporations. The key mechanism explaining our findings is the increased physical proximity of lenders to small informationally opaque borrowers. Our results show that financial deepening, by bringing lenders closer to borrowers, can aid in the relaxation of credit constraints in emerging economies with imperfect capital and credit markets.

Keywords: Branch Expansions, Credit Constraints, Private Banks, Credit Growth, Small and Micro-Enterprises

JEL Classification: G21, D22, D24, O16