Determinants of SME Loan Default: The Importance of Borrower-Level Heterogeneity
Using unique borrower-level balance sheet information for a cross-section of 6,000 Irish SME loans, this paper tests the determinants of default at the micro level. Typical financial ratios, such as the ratio of the loan to total assets, the current ratio, leverage ratio, liquidity ratio and profitability ratio, are found to be significant predictors of default. Further, the length of time the borrowing firm’s owner has been with the firm mitigates the likelihood of default. Conditional on the above, significant sector-level effects remain. The paper moves beyond average effects of the above-mentioned variables by repeating the analysis across seven sectors of economic activity, and across the quintiles of firm size, exposure and credit quality. The share of defaults is shown to fall as firms get larger, and to rise as loans get larger relative to assets. The results suggest that different warning signals can be identified, particularly for borrowers of different sizes and with small versus large loans. These results contribute to the literature on “fundamentals-based” modelling of corporate default risk, and represent one of very few sets of results on the determinants of default in SME lending in particular.
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