This paper analyzes the relation between the quality of the legal enforcement of loan contracts and the allocation of credit to households, both theoretically and empirically. We use a model of household credit market with secured debt contracts, where the judicial system affects the cost incurred by banks to actually repossess the collateral. The model shows that the working of the judicial system affects both the probability of being credit-constrained and the equilibrium amount of debt. In the empirical part, we test our predictions using data on Italian households and on the performance of Italian judicial districts. Controlling for household characteristics, unobserved heterogeneity at judicial district level and aggregate shocks, we document that an increment in the backlog of trials pending has a statistically and economically significant positive effect on the household probability of being turned down from the credit. Endowing the households living in high-cost judicial districts like Campobasso or Caltanissetta (in southern Italy) with the best enforcement in the sample would reduce the probability of their being credit-constrained by 70% and 63%, respectively. This effect is stronger for poorer than for wealthier households. Moreover, we document that an increment in the backlog of trials pending reduces the availability of credit for poorer households but, surprisingly, has the opposite effect on wealthy households, whose debt volume increases. Again, this effect is found to be significant both statistically and economically.
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Paper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number
rp81.
Find related papers by JEL classification: D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation K12 - Law and Economics - - Basic Areas of Law - - - Contract Law K41 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Litigation Process K42 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Illegal Behavior and the Enforcement of Law
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