Nº 20-50: The Conflict Induced Costs of Lending

We study the effect of armed conflict on loan officers and their actual lending decisions. Following mortar shelling of Indian border areas in the state of Jammu & Kashmir, we document that after repeated incidences of shelling the loan rates set by the loan officers exponentially increase. While the immediate effect may be driven by a rational response due to altering beliefs, the later rate hikes suggest an increase over and above the equilibrium response. Our study reveals that the real costs of armed conflict through loan pricing are not trivial, and what we document is informative about liquidity shortfalls or credit spirals arising from non-conflictuous political, economic or pandemic shocks.