Reexamining the Empirical Relation between Loan Risk and Collateral: The Role of the Economic Characteristics of Collateral

European Banking Center Discussion Paper No. 2012-020

CentER Discussion Paper Series No. 2012-078

34 Pages Posted: 24 Sep 2012

See all articles by Allen N. Berger

Allen N. Berger

University of South Carolina - Darla Moore School of Business; Wharton Financial Institutions Center; European Banking Center

W. Scott Frame

Federal Reserve Bank of Dallas

Vasso Ioannidou

Lancaster University - Management School; Centre for Economic Policy Research (CEPR)

Date Written: September 24, 2012

Abstract

This paper offers a possible explanation for the conflicting results in the literature concerning the empirical relation between collateral and loan risk. We posit that certain economic characteristics of collateral may be associated with the empirical dominance of different risk-collateral channels implied by economic theory, namely the “lender selection,” “borrower selection,” “risk-shifting,” and “loss mitigation” channels. Each of these four channels has different predictions regarding the empirical relations between collateral and loan risk. For our sample of commercial loans, we find that the “lender selection” channel appears to be especially important for outside collateral, the “risk-shifting” and “loss mitigation” channels are important for liquid collateral, and the “borrower selection” channel appears to hold weakly for nondivertible collateral. Our results suggest that the conflicting results in the extant risk collateral literature may occur because different samples may be dominated by collateral with different economic characteristics.

Keywords: Collateral, Asymmetric Information, Banks

JEL Classification: G21, D82, G38

Suggested Citation

Berger, Allen N. and Frame, W. Scott and Ioannidou, Vasso, Reexamining the Empirical Relation between Loan Risk and Collateral: The Role of the Economic Characteristics of Collateral (September 24, 2012). CentER Discussion Paper Series No. 2012-078. Available at SSRN: https://ssrn.com/abstract=2151212 or http://dx.doi.org/10.2139/ssrn.2151212

Allen N. Berger (Contact Author)

University of South Carolina - Darla Moore School of Business ( email )

1705 College St
Francis M. Hipp Building
Columbia, SC 29208
United States
803-576-8440 (Phone)
803-777-6876 (Fax)

Wharton Financial Institutions Center

Philadelphia, PA 19104-6367
United States

European Banking Center

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

W. Scott Frame

Federal Reserve Bank of Dallas ( email )

2200 N Pearl Street
Dallas, TX 75201
United States
214-922-6984 (Phone)

Vasso Ioannidou

Lancaster University - Management School ( email )

Bailrigg
Lancaster, LA1 4YX
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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