Collateral Spread and Financial Development

Abstract

We show that institutions that promotional development ease borrowing constraints by lowering the collateral spread, and shifting the composition of acceptable collateral towards firm-specific assets. Using a novel cross-country loan-level data set, we estimate collateral spread as the difference in rates of collateralization between high and low risk borrowers in a given economy. The average collateral spread is large but declines rapidly with financial development. A one standard deviation improvement in financial development due to stronger institutions leads to a reduction in collateral spread by one-half. We also find that the composition of collateralizable assets shifts towards non-specific assets (e.g. land) with increased risk. However, this shift is considerably smaller in more developed financial markets, thus enabling risky borrowers to use a larger variety of assets as collateral.

Keywords: collateral, financial development, banks, emerging markets

JEL Classification: G21, G33, K11, K12, O12