Law, Institutions and Economic Development: Examining the Development of the Home Mortgage Market in India - Can Two Wrongs Make a Right?

Vikramaditya S. Khanna (University of Michigan Law School)

Abstract: A vast literature examines the interactions between law, institutions and economic development, but it only occasionally examines how actual markets in emerging economies have developed and transitioned to relying on legal institutions. This paper addresses that question by examining the growth of the formal home mortgage market (HMM) in India from the mid 1990s onwards. Long delays in foreclosing on property, along with other factors, led to a trivial HMM. However, from about 1994 to 2003, and before any mortgage law changes took effect, the HMM in India grew impressively. This paper examines what led to this and finds that, amongst other things, banks in India relied on “dysfunctions” in the criminal justice system to help overcome dysfunctions in the civil justice system for enforcing mortgages. In particular, in house departments at banks relied on a provision that criminalized “bounced” checks along with the predictability of extortion by the police to enhance their ability to obtain payments for mortgages and other kinds of debts. Although this aided the HMM’s growth, it also resulted in substantial negative collateral effects by enhancing corruption and worsening adjudicative delays. Indeed, the “bounced” check strategy (BCS) came to represent one of the largest areas of litigation in India. However, once the mortgage market started growing banks pushed for law changes around 2003 that facilitated the continued expansion of the market, but reduced the need to rely on the increasingly costly BCS. The HMM’s development not only tracks the incentives faced by the players and highlights the improvisational aspects of this market’s growth, but also has implications for a number of areas of research. This includes insights on the interactions between law, institutions and economic development; how institutional change or transition might arise in some contexts; and the role of private ordering, and key players like in-house lawyers, in market development.

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