Banks' Reactions to Creditor Rights Changes

Abstract

We study how banks adjust their portfolios in response to a deterioration in creditor rights. We construct a comprehensive creditor rights index based on a series of quasi-natural experiments in Italy and exploit a unique proprietary credit-level database of one of the largest Italian banks. Our data includes the universe of the bank’s portfolio over time, allowing us to provide evidence on the banks’ reaction to changes in creditor rights. We document a fall in recovery rates, an increase in interest rates, and a reduction in credit. There is also a movement away from smaller firms and towards secured loans with floating rates. Features such as the strength of lending relationships and the bank’s market power mitigate the magnitudes of these responses. Our analysis reveals that these features constitute important tools to attenuate the effect of poor creditor rights on firms’ access to financing. Our results support the seminal works of Rajan (1992) and Petersen and Rajan (1995).

Keywords: Creditor Rights, SME, Relationship Lending, Bank Power

JEL Classification: G21, G28, G33, G38