The issue and relevance of financial misconduct and fear of prosecution on the lending behaviour of Indian banks is investigated by combining bank-level financial and prudential variables during 2008–18 with a unique hand-collected data set on financial misconduct and fear of prosecution. The findings indicate that, in the presence of financial misconduct, state-owned banks typically cut back on credit creation and instead increase their quantum of risk-free investment. In terms of magnitude, a 10% increase in financial misconduct lowers lending by 0.2% along with a roughly commensurate increase in investment. In terms of the channels, it is found that private banks increase provisioning to maintain their credit growth, although the evidence for state-owned banks is less persuasive.
