Political connections and preferential lending at local level: Some evidence from the Italian credit market

- We investigate the effect of political connections on the Italian credit markets.
- Connected firms benefit from lower interest rates when the link is at a local level.
- The effect is stronger when both firms and banks have politicians in their boards.
- The degree of autonomy granted to local loan officers plays an important role.
- The discount in interest rates is higher in areas with larger incidence of corruption.

We investigate the effect of political connections in Italy, for each level of government, on the credit markets and we find robust evidence that politically connected firms benefit from lower interest rates when the political link is at a local level. Our results show that this preferential treatment is stronger when connected firms borrow from banks with politicians on their boards and when the degree of autonomy granted to local loan officers is higher. The latter result provides a novel addition to the literature on the effects of the delegation of lending decisions within the bank. We also show that the effect is stronger in geographical areas where the incidence of corruption is higher. Overall, our results show that on aggregate the impact of political connections on interest rates is limited but it may rise significantly in specific (local) situations due to a combination of factors such as the delegation of lending decisions, a weaker rule of law and some governance characteristics of banks.