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Contracting without Contracting Institutions: The Trusted Assistant Loan in 19th Century China

Journal: Journal of Financial Economics

Date: 20210601

Author: Miao, Meng; Niu, Guanjie; Noe, Thomas

Abstract:
This paper documents the emergence of a large bank loan market in the absence of contracting institutions: the trusted assistant loan market in 19th century China. These loans were legally unenforceable, one-shot loans to poor scholars that funded the costs of assuming lucrative administrative appointments offering ample opportunities for corruption. The trusted assistant loan's distinguishing feature was a legally unenforceable stipulation that the borrower incorporate an agent of the creditor into his administrative cadre. We model the enforcement of these loans through expertise leverage and test the model's predictions using data from officials' diaries and a bank loan book.

Link: Google Scholar

Key Findings

Large-Scale Lending Without Legal Enforcement

The trusted assistant loan market in 19th century China operated at scale despite no legal enforcement mechanisms, with loans worth approximately 6.3 million taels of silver.

Bank-Dominated Lending

Chinese banks provided 90% of trusted assistant loans, with loans enforced through expertise leverage rather than traditional contracting institutions.

Higher Recovery Rates

Trusted assistant loans showed higher recovery rates and longer actual maturities compared to regular loans, demonstrating the effectiveness of the expertise leverage mechanism.

Loan Market Composition

  • Chinese banks dominated the market with 148 out of 165 total loans
  • Only 17 loans were from relatives or friends
  • Shows the impersonal nature of the lending market

Loan Recovery Performance

  • Trusted assistant loans had average recovery rate of 62.21%
  • Non-trusted assistant loans showed 86.28% recovery rate
  • Demonstrates effectiveness of expertise leverage enforcement mechanism

Loan Characteristics Comparison

  • Trusted assistant loans were larger (2,494 vs 1,380 taels)
  • Had longer actual maturities (2.0 vs 1.63 years)
  • Slightly lower interest rates (19.73% vs 20.28%)

Contribution and Implications

  • Demonstrates that large-scale financial markets can operate without formal legal enforcement mechanisms
  • Shows how expertise leverage can substitute for traditional contracting institutions
  • Provides insights into alternative enforcement mechanisms in financial markets

Data Sources

  • Loan composition chart based on Panel B of Table 2
  • Recovery rates visualization based on Panel F of Table 2
  • Loan characteristics comparison based on Panels E and F of Table 2