Diversion of loan use: evidence from rural West Bengal, India

Present paper explores spending behaviour of loan proceeds and identifies the effect of different socio-economic and political factors on the probability of loan diversion using a primary household survey data drawn from four villages of state of West Bengal, India. Loan diversion refers to the incidence where institutional borrowers use total or part of their loan for purposes that was not specified during the borrowing. Survey reveals that institutional loans taken for working capital needs are mostly diverted either partly or fully and mainly for household expenditure. This study considers Heckman sample selection model, considering the sample selection bias. Results show that religion, age, support of political party and financial literacy of principal earner significantly increases probability of loan diversion. The study also investigates the joint probability of indebtedness and loan diversion; multiple borrowing and loan diversion; indebtedness and institutional borrowing and socio-economic determinants by using bivariate probit model.