the presence of economies of scale in political lending, and with the fact that the leadership of domestic banks tends to have stronger relations with national politicians.

We also study the dynamics of political lending along the political cycle by focusing on the chairman's three-year term. We find that the impact of the chairman's presence contributes to a persistent increase in lending during the legislative session, reaching a peak as the upcoming congressional elections near. Specifically, on average there is little effect of political connections in the first and second years of a chairman’s term, but in the third year the impact of political loans increases with average loan volume increasing on average 1.5 percent.

We further investigate the effect of political lending on the firm’s real economic activity and find a strong and significant effect on employment outcomes. More concretely, the chairmanship of a given committee is associated with a 2.1 percent increase in employment in firms headquartered in the chairman’s state. We also find an impact on the firm’s finances, including total assets, liabilities and revenues. Consistent with frictions due to asymmetric information in the “large versus small” literature, the impact of credit supply channel varies with firm size, and the effect is significantly stronger for small firms.

As reward for offering political rents, we document that banks that engage more in political lending receive significantly more government borrowings, and with better quality. This finding suggests that politicians use their political power over government borrowing to offer benefits to banks in return for political loans.

To explore the robustness of our findings, we conduct a series of tests to rule out alternative explanations and show the pattern holds under a variety of specifications. First, we address the concern that the chairmanship may be selected based on the economic performance of the chairman’s state. Second, we find that the politically connected firm receives greater preferential treatment when its politician has stronger political power. Third, we show that the political rent does not vary with the firm size, contradicting the social purpose lending hypothesis predicting relatively more political lending for small firms. Finally, we run falsification tests by randomly assigning the state of each chairman and show that the political lending pattern disappears. Finally, we rerun the same specifications using the less relevant commissions when constructing the measure of political connection and find that the effect wanes.

Given the comprehensive coverage of our loan data, we estimate the economic cost of the documented political rents by focusing on the two dimensions that we can infer from the data. First, the deadweight loss from the increase in default loans is estimated to be 0.4 basis point of Mexico’s annual GDP. Given an OECD report that the cost of political rents averages about 5 percent of the total GDP, political lending comprises 0.08 percent of total amount of political rents in Mexico.<sup>6</sup> Second, we document evidence of additional distortion of commercial credit allocation: firms in

> 6 The report can be found at http://www.oecd.org/cleangovbiz/49693613.pdf.

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