Firms as Monitors of Other Firms: Evidence from Sme Finance

39 Pages Posted: 21 Mar 2008

See all articles by Francesco Columba

Francesco Columba

Bank of Italy

Leonardo Gambacorta

Bank for International Settlements (BIS); Centre for Economic Policy Research (CEPR)

Paolo Emilio Mistrulli

Bank of Italy

Date Written: March 12, 2008

Abstract

A large body of literature has shown that small firms, due to their opaqueness, may find it difficult to access the credit market. Informational asymmetries may be mitigated by posting collateral or by building relationships with lenders (relationship lending). However, in some cases, due to a lack of collateral or of a long credit history, small enterprises may still find it very difficult to raise external finance unless alternative contracting schemes emerge. In particular, group lending or similarly micro-finance are examples of such alternative lending contracts. In this paper, we investigate the effect of mutual loan guarantee consortia (MLGC) on loan interest rates. We argue that, similarly to group lending and micro-finance, firms affiliated to a MLGC are linked by a joint responsibility for the loan providing MLGC affiliates with peer monitoring incentives. Indeed, each MLGC member contributes to the guarantee fund that is then posted as collateral to loans granted to MLGC members. As a consequence, MLGC willingness to post collateral signals firms credit-worthiness to banks. The econometric analysis exploits a unique data-set extracted from the Italian Credit Register with 350,000 observations on bank loans to 260,000 SMEs. The main results support the hypothesis that MLGC improve lending conditions for small firms and are the following. First, small firms affiliated with a MLGC obtain finance at interest rates that are significantly lower than other small firms; the benefit is greater for small firms located in the South where asymmetric information problems are the most severe. Second, affiliated firms have a probability to go into default lower than other firms with the same characteristics; the probability to go into default drops considerably if the firm is located in the South. Third, an increase in the number of firms affiliated to a MLGC improves the peer-monitoring effect but up to a limit; when the number of borrowers in the group increases too much, the free riding problem overcomes the benefits of peer monitoring coming from additional firms.

Keywords: credit guarantee schemes, group lending, joint liability, microfinance, peer monitoring, small business finance

JEL Classification: D82, G21, G30, O16

Suggested Citation

Columba, Francesco and Gambacorta, Leonardo and Mistrulli, Paolo Emilio, Firms as Monitors of Other Firms: Evidence from Sme Finance (March 12, 2008). Available at SSRN: https://ssrn.com/abstract=1105603 or http://dx.doi.org/10.2139/ssrn.1105603

Francesco Columba (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy
+39-06-47922131 (Phone)
+39-09-47923611 (Fax)

Leonardo Gambacorta

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Paolo Emilio Mistrulli

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy

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