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Collateral, Default Risk, and Relationship Lending: An Empirical Study on Financial Contracting

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  • Krahnen, Jan Pieter

Abstract

This paper provides new insights into the nature of relationship lending by analysing the role of collateral and its real effects with respect to workout activities. We use a unique data set based on the credit files of five leading German banks, thus relying on real information used in the process of bank credit decision-making. In particular, risk assessment is derived from bank internal borrower ratings, and a new proxy for identifying relationship lending is used. Furthermore, our data set contains information on banks workout activities relating to borrowers facing financial distress. We find no significant correlation between borrower quality and the incidence of collateralization, or the degree thereof. Our results indicate that the use of collateral in loan contracts is mainly driven by aspects of relationship lending and renegotiation risk. Relationship lenders do require more collateral from their debtors than normal lenders for two main reasons. First, collateral locks the borrower into the relationship. Second, it strengthens the bank’s bargaining power in future renegotiations. This interpretation is strongly supported by our analysis of bank behaviour when borrowers face financial distress. We find that workout activities for distressed borrowers are positively related to both the housebank status and the degree of collateralization.

Suggested Citation

  • Krahnen, Jan Pieter, 2000. "Collateral, Default Risk, and Relationship Lending: An Empirical Study on Financial Contracting," CEPR Discussion Papers 2540, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:2540
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    Cited by:

    1. Ono, Arito & Uesugi, Iichiro, 2008. "The Role of Collateral and Personal Guarantees in Relationship Lending: Evidence from Japan's SME Loan Market," PIE/CIS Discussion Paper 371, Center for Intergenerational Studies, Institute of Economic Research, Hitotsubashi University.
    2. Bellucci, Andrea & Borisov, Alexander & Giombini, Germana & Zazzaro, Alberto, 2015. "Collateral and Local Lending: Testing the Lender-Based Theory," HIT-REFINED Working Paper Series 21, Institute of Economic Research, Hitotsubashi University.
    3. Aivazian, Varouj & Gu, Xinhua & Qiu, Jiaping & Huang, Bihong, 2015. "Loan collateral, corporate investment, and business cycle," Journal of Banking & Finance, Elsevier, vol. 55(C), pages 380-392.
    4. Menkhoff, Lukas & Neuberger, Doris & Rungruxsirivorn, Ornsiri, 2012. "Collateral and its substitutes in emerging markets’ lending," Journal of Banking & Finance, Elsevier, vol. 36(3), pages 817-834.
    5. Berger, Allen N. & Scott Frame, W. & Ioannidou, Vasso, 2011. "Tests of ex ante versus ex post theories of collateral using private and public information," Journal of Financial Economics, Elsevier, vol. 100(1), pages 85-97, April.
    6. repec:eee:ememar:v:33:y:2017:i:c:p:19-41 is not listed on IDEAS
    7. Menkhoff, Lukas & Neuberger, Doris & Suwanaporn, Chodechai, 2006. "Collateral-based lending in emerging markets: Evidence from Thailand," Journal of Banking & Finance, Elsevier, vol. 30(1), pages 1-21, January.
    8. Antje Brunner & Jan Pieter Krahnen, 2008. "Multiple Lenders and Corporate Distress: Evidence on Debt Restructuring," Review of Economic Studies, Oxford University Press, vol. 75(2), pages 415-442.
    9. Leonardo Becchetti & Melody Garcia, 2008. "Do collateral theories work in social banking ?," CEIS Research Paper 131, Tor Vergata University, CEIS, revised 07 Nov 2008.
    10. Pozzolo, Alberto Franco, 2004. "The Role of Guarantees in Bank Lending," Economics & Statistics Discussion Papers esdp04021, University of Molise, Dept. EGSeI.
    11. Berger, Allen N. & Espinosa-Vega, Marco A. & Frame, W. Scott & Miller, Nathan H., 2011. "Why do borrowers pledge collateral? New empirical evidence on the role of asymmetric information," Journal of Financial Intermediation, Elsevier, vol. 20(1), pages 55-70, January.
    12. Massimo Omiccioli, 2005. "Trade Credit as Collateral," Temi di discussione (Economic working papers) 553, Bank of Italy, Economic Research and International Relations Area.
    13. HOSONO Kaoru & XU Peng, 2009. "Do Banks Have Private Information? Bank screening and ex-post small firm performance," Discussion papers 09016, Research Institute of Economy, Trade and Industry (RIETI).
    14. Tensie Steijvers & Wim Voordeckers & Koen Vanhoof, 2010. "Collateral, relationship lending and family firms," Small Business Economics, Springer, vol. 34(3), pages 243-259, April.
    15. Tra, Pham Thi Thu & Lensink, Robert, 2006. "The Determinants of Loan Contracts to Business Firms: Empirical Evidence from a Private Bank in Vietnam," WIDER Working Paper Series 086, World Institute for Development Economic Research (UNU-WIDER).
    16. Jose Maria Liberti, 2004. "Initiative, Incentives and Soft Information. How Does Delegation Impact The Role of Bank Relationship Managers?," Finance 0404023, EconWPA.
    17. Voordeckers, Wim & Steijvers, Tensie, 2006. "Business collateral and personal commitments in SME lending," Journal of Banking & Finance, Elsevier, vol. 30(11), pages 3067-3086, November.

    More about this item

    Keywords

    Collateral; Housebanks; Loan Contract Design; Relationship Lending; Workouts;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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