Collateralization, Bank Loan Rates and Monitoring: Evidence from a Natural Experiment

Abstract:     
We study a change in the Swedish law that exogenously reduced the value of all outstanding company mortgages, i.e., a type of collateral that is comparable to the floating lien. We explore this natural experiment to identify how collateral determines borrower quality, loan terms, access to credit and bank monitoring of business term loans. Using a differences-in-differences approach, we find that following the change in the law and the loss in collateral value borrowers pay a higher interest rate on their loans, receive a worse quality assessment by their bank, and experience a substantial reduction in the supply of credit by their bank. The reduction in collateral value also precedes a decrease in bank monitoring intensity and frequency of both the collateral and the borrower, consistent with models in which the pledging of risky assets incentivizes banks to monitor.

Number of Pages in PDF File: 37

Keywords: Collateral, credit rationing, differences-in-differences, floating lien, loan contracts, monitoring, natural experiment

JEL Classification: D82, G21

working papers series