Related Lending and Economic Performance: Evidence from Mexico

Related lending, a widespread practice in LDCs, is widely held to encourage bankers to loot their banks at the expense of minority shareholders and depositors. We argue that neither looting nor credit misallocation arenecessary outcomesof related lending. On the contrary, related lending often exists as a response to high information and contract-enforcement costs. Whether it encourages looting depends on other institutions, particularly those that create incentives to monitor directors. We examine Mexico's banking system, 1888–1913, in which there was widespread related lending. We find little evidence of credit misallocation, despite a financial crisis and government-organized rescue.