Insider Lending and Bank Ownership: The Case of Russia

Abstract

We develop a model of insider lending in which a borrower can give incentives to a bank manager to misuse his right of control by extending a loan at favorable rates to the borrower at the expense of the equity value of the bank. The model explains why insider loans often occur to borrowing firms that are also large shareholders of the bank. The reason is that, although in principal every borrower could bribe the bank manager for insider loans, large shareholders have the power to fire the bank manager, and will use this power if the bank manager extends insider loans to others. Therefore, a bank manager has a reason to favor large shareholders if engaging into insider lending. Using a World Bank survey of Russian enterprises we provide evidence of our model. We find that Russian firms and banks engaged into insider lending on the basis of loan volume. To limit insider lending we propose to give proper incentives to bank managers, such as high penalties or equity incentive schemes.

Keywords: Insider lending, bank ownership

JEL Classification: D82, G21, G32, G38, P50