Reexamining the Empirical Relation between Loan Risk and Collateral: The Roles of Collateral Characteristics and Types

25 Pages Posted: 10 Aug 2017

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 Atlanta

Vasso Ioannidou

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

Date Written: September 1, 2011

Abstract

This paper offers a possible explanation for the conflicting empirical results in the literature concerning the relation between loan risk and collateral. Specifically, we posit that different economic characteristics or types of collateral pledges may be associated with the empirical dominance of the four different risk-collateral channels implied by economic theory. For our sample, collateral overall is associated with lower loan risk premiums and a higher probability of ex post loan nonperformance (delinquency or default). This finding suggests that the dominant reason collateral is pledged is that banks require collateral from observably riskier borrowers (“lender selection” effect), while lower risk premiums arise because secured loans carry lower losses given default (“loss mitigation” effect). We also find that the risk-collateral channels depend on the economic characteristics and types of collateral. The lender selection effect appears to be especially important for outside collateral, the “risk-shifting” or “loss mitigation” effects for liquid collateral, and the “borrower selection” effect for nondivertible collateral. Among collateral types, we find that the lender selection effect is particularly strong for residential real estate collateral and that the risk shifting effect is important for pledged deposits and bank guarantees. Our results suggest that the conflicting results in the extant riskcollateral literature may be because different samples may be dominated by collateralized loans with different economic characteristics or different types of collateral.

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 Roles of Collateral Characteristics and Types (September 1, 2011). FRB Atlanta Working Paper No. 2011-12. Available at SSRN: https://ssrn.com/abstract=2481055

Allen N. Berger

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 (Contact Author)

Federal Reserve Bank of Atlanta ( email )

1000 Peachtree Street, NE
Atlanta, GA 30309-4470
United States
404 498 8783 (Phone)
404 498 8810 (Fax)

Vasso Ioannidou

Lancaster University - Management School ( email )

Bailrigg
Lancaster, LA1 4YX
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Register to save articles to
your library

Register

Paper statistics

Downloads
15
Abstract Views
175
PlumX Metrics