Collateral, Labour Monitoring and Banking Accelerator

Abstract

This paper derives the determination of external finance premium (EFP) in the context of banking sector profit maximisation behaviour. EFP/credit spread stems from the managerial cost, associated with the intermediation process, of factor payments to collateral and labour services. The stake of entrepreneurs is relevant to determine the on two grounds: (a) the ratio of entrepreneurial net wealth to collateral value influences the total managerial cost; and (b) entrepreneurs' net worth (fraction of total collateral) helps mitigate the from extracting rebate from collateral service. Based on these, we can derive an observationally similar relationship between and entrepreneurial leverage, as in previous studies. This provides a rationale for us to understand the financial friction from a novel perspective. Besides the leverage ratio, the is shown to be determined also by the resource cost of financial intermediation, for which the model generates a mechanism that contains broader ingredients in determining the behaviour of EFP.

Keywords: external finance premium, financial frictions, impulse responses, loan production

JEL Classification: E32, E44, E52, G21