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Why Do Banks Ask for Collateral and Which Ones ?

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Listed author(s):
  • Régis Blazy
  • Laurent Weill

    ()

    (Laboratoire de Recherche en Gestion et Economie, Institut d'Etudes Politiques, Strasbourg)

Abstract

This paper aims at testing empirically the three major theoretical reasons why banks resort to collateral: reduction of loan loss in the event of default, adverse selection, and moral hazard. This investigation is performed by testing whether the reasons vary according to the type of collateral. We use a unique dataset of bank loans granted to French distressed firms, which contains the full information on debt contract characteristics, including the cause of default, the type and the value of all collaterals. Our work suggests that information asymmetries are not of prime importance in the decision of the bank to secure a loan, as no type of collateral helps to solve adverse selection and moral hazard problems. The reduction of the loan loss and the observed-risk hypothesis may however explain the use of collateral.

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Paper provided by Laboratoire de Recherche en Gestion et Economie (LaRGE), Université de Strasbourg in its series Working Papers of LaRGE Research Center with number 2006-03.

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Date of creation: 2006
Handle: RePEc:lar:wpaper:2006-03
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Keywords: Collateral; Bank; Credit Risk.;

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Find related papers by JEL classification:
  • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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  1. Degryse, Hans & Van Cayseele, Patrick, 2000. "Relationship Lending within a Bank-Based System: Evidence from European Small Business Data," Journal of Financial Intermediation, Elsevier, vol. 9(1), pages 90-109, January.
  2. Jimenez, Gabriel & Saurina, Jesus, 2004. "Collateral, type of lender and relationship banking as determinants of credit risk," Journal of Banking & Finance, Elsevier, vol. 28(9), pages 2191-2212, September.
  3. Berger, Allen N & Udell, Gregory F, 1995. "Relationship Lending and Lines of Credit in Small Firm Finance," The Journal of Business, University of Chicago Press, vol. 68(3), pages 351-381, July.
  4. Heather M. Hulburt & Frederick C. Scherr, 2003. "Determinants of the collateralization of credit by small firms," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 24(6-7), pages 483-501.
  5. Leeth, John D. & Scott, Jonathan A., 1989. "The Incidence of Secured Debt: Evidence from the Small Business Community," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(03), pages 379-394, September.
  6. Besanko, David & Thakor, Anjan V, 1987. "Collateral and Rationing: Sorting Equilibria in Monopolistic and Competitive Credit Markets," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(3), pages 671-689, October.
  7. Jimenez, Gabriel & Salas, Vicente & Saurina, Jesus, 2006. "Determinants of collateral," Journal of Financial Economics, Elsevier, vol. 81(2), pages 255-281, August.
  8. Marc Cowling, 1999. "The incidence of loan collateralization in small business lending contracts: evidence from the UK," Applied Economics Letters, Taylor & Francis Journals, vol. 6(5), pages 291-293.
  9. John S. Gonas & Michael J. Highfield & Donald J. Mullineaux, 2004. "When Are Commercial Loans Secured?," The Financial Review, Eastern Finance Association, vol. 39(1), pages 79-99, 02.
  10. Boot, Arnoud W A & Thakor, Anjan V & Udell, Gregory F, 1991. "Secured Lending and Default Risk: Equilibrium Analysis, Policy Implications and Empirical Results," Economic Journal, Royal Economic Society, vol. 101(406), pages 458-472, May.
  11. Harhoff, Dietmar & Korting, Timm, 1998. "Lending relationships in Germany - Empirical evidence from survey data," Journal of Banking & Finance, Elsevier, vol. 22(10-11), pages 1317-1353, October.
  12. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  13. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-855, September.
  14. Berger, Allen N. & Udell, Gregory F., 1990. "Collateral, loan quality and bank risk," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 21-42, January.
  15. Booth, James R. & Booth, Lena Chua, 2006. "Loan Collateral Decisions and Corporate Borrowing Costs," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(1), pages 67-90, February.
  16. Chan, Yuk-Shee & Kanatas, George, 1985. "Asymmetric Valuations and the Role of Collateral in Loan Agreements," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 17(1), pages 84-95, February.
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Cited by:

  1. Evžen Kocenda & Martin Vojtek, 2011. "Default Predictors in Retail Credit Scoring: Evidence from Czech Banking Data," Emerging Markets Finance and Trade, M.E. Sharpe, Inc., vol. 47(6), pages 80-98, November.
  2. Fidrmuc, Jarko & Hainz, Christa, 2010. "Default rates in the loan market for SMEs: Evidence from Slovakia," Economic Systems, Elsevier, vol. 34(2), pages 133-147, June.
  3. Amedeo Argentiero, 2009. "Some New Evidence on the Role of Collateral: Lazy Banks or Diligent Banks?," ISAE Working Papers 113, ISTAT - Italian National Institute of Statistics - (Rome, ITALY).

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