the chairman’s state but not in an industry under its purview suffer from credit under-provision as a result of the political lending. Finally, we show that banks reap a net benefit from engaging in the rent provision activity of 1.6 percent of their annual net income.

<mark>Two potential mechanisms can explain our results: i) Politicians exert influence on banks through bank management appointments (Khwaja and Mian, 2005; Carvalho, 2014). This mechanism however is most likely prevalent in economies with public banks where management appointments are controlled by politicians; ii) Banks channel lending to politically connected firms to exchange favors with politicians. In these settings, politicians may channel additional lending to their state and sector to benefit in upcoming elections. Our results provide support for this view. That is, though the lending decision of private banks is not subject to direct pressure from politicians, banks have incentives to adapt to political developments and adjust lending to cater to the needs of politicians as an alternative way of campaign contributions and lobbying. The benefits may include additional revenue to the bank’s business, that we provide evidence for in the paper, favorable policies and regulations (Dinc, 2005; Kostovetsky, 2015) and personal “perks” to bank top management (Bertrand et al, 2007).</mark><sup>7</sup> Our paper builds on the work by Sapienza (2004) and Khwaja and Mian (2005) and makes four important contributions to the literature. First, unlike the prior literature studying political rent seeking in public sector banks, we focus on an economy with a fully privatized banking sector where the existence of political rent seeking is not obvious. While privatization should help eliminate the politically motivated resource allocation, increase efficiency and ultimately diminish rent-seeking behavior, we document the existence of significant political rents in the Mexican banking sector. Second, using a time-varying measure, we exploit within-firm variation by comparing a firm’s loan terms and performance when it is politically connected and when it is not. The political connection measure used in our paper, firms operating in the politician's state, allows us to target a broader sample of borrowers and thus provide a more general evidence of political rents in banking. Third, using a matched bank-firm data, we show how political considerations in bank lending have important effects on firm’s real economic outcomes. Specifically, we show that firms use the excess credit supply to hire new employees and to increase their assets. Finally, we provide evidence of _quid pro quo_ as banks that extend more political loans receive more and better public loans.

**Related Research -** Our paper adds to the literature of political distortions in the supply of credit. It most closely relates to Sapienza (2004) and Khwaja and Mian (2005) as they also use loan-level data to study how political connections affect bank lending. Sapienza (2004) presents evidence of Italian state-owned banks used as instruments in the supply of political patronage: firms located in an area with a relatively stronger political party affiliation obtained lower loan spread. Similarly,

> 7 One concern is that private banks do not have the advantage of soft budget constraints like government organizations. However, given that our estimates are smaller relative to the case of government lending, the concern of whether the rent provision can sustain is less of a problem.

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