24 Pages Posted: 12 May 2004
Guarantees have a primary role in debt contracts. They alter the risk for the lender, transform borrowers' incentives and, eventually, modify the equilibrium allocation of financial resources. This paper studies the role of guarantees on bank loans, using a sample of over 50,000 individual lines of credit granted by Italian banks. Two empirical models are used. The first directly verifies the relationship between ex-ante publicly available information on borrowers' default riskiness and the presence of guarantees on their bank loans; the second compares the interest rates charged on secured and unsecured loans made by different banks to a same borrower, thus perfectly controlling for its idiosyncratic riskiness and singling out the direct effect of the presence of guarantees on credit risk. The empirical results show that real guarantees (physical assets or equities that the lender can sell to obtain the payments in case of default of the borrower), that are often internal, are mainly used to provide a priority to some creditors. Personal guarantees (contractual obligations of third parties to make payments in case of default of the borrower, e.g., suretyships), that can only be external, are used instead as incentive devices against moral hazard problems. Controlling for borrowers' characteristics, both real and personal guarantees reduce ex-ante credit risk.
Notes: Previously titled "Secured Lending and Borrowers' Riskiness"
Keywords: Bank loans, collateral, guarantee
JEL Classification: G21, G32
Suggested Citation: Suggested Citation
By Jeremy Stein
By Jeremy Stein