Collateral and its substitutes in emerging markets’ lending

Due to opaque information and weak enforcement in emerging loan markets, the need for collateral is high, whereas borrowers lack adequate assets to pledge as collateral. How is this puzzle solved? We find for a representative sample from Northeast Thailand that indeed most loans do not include any tangible assets as collateral. Instead, lenders enforce collateral-free loans through third-party guarantees and relationship lending, but also through modifying loan terms, such as reducing loan size. Guarantees are the relatively most important substitute, they reduce collateral requirements independently of relationship lending and they are more often used by formal financial institutions.     

Loan collateral and financial reporting conservatism: Chinese evidence

We examine the relation between the use of collateral and financial reporting conservatism for a sample of Chinese firms. In the absence of flexibility in risk pricing through interest rates and strong contract enforcement in China, we find that lenders reduce collateral requirements from more conservative borrowers and that this negative relation is significantly moderated by borrowers’ poor credit quality and low asset tangibility. Our finding that conservatism can result in a tangible benefit in the form of lower collateral requirements indicates that lenders value financial reporting conservatism. However, the benefit from financial reporting conservatism is muted as lenders become more concerned about borrowers’ default risk or ability to pledge tangible assets as collateral against loans.     

ARE FIRM‐ AND COUNTRY‐SPECIFIC GOVERNANCE SUBSTITUTES? EVIDENCE FROM FINANCIAL CONTRACTS IN EMERGING MARKETS

We investigate how borrowers’ corporate governance influences bank loan contracting terms in emerging markets and how this relation varies across countries with different country‐level governance. We find that borrowers with stronger corporate governance obtain favorable contracting terms with respect to loan amount, maturity, collateral requirements, and spread. Firm‐level and country‐level corporate governance are substitutes in writing and enforcing financial contracts. We also find that the distinctiveness of borrowers’ characteristics affect the relation between firm‐level corporate governance and loan contracting terms. Our findings are robust, irrespective of types of regression methods and specifications.     

The value of relationship banking: International evidence

This paper analyses whether repeated borrowing from the same bank affects loan contract terms. We find that relationship loans pay less spread and require less collateral compared to non-relationship loans. These effects for relationship loans are not derived from differences between relationship and nonrelationship loans. The reduction of interest rate spread for relationship loans disappeared during the financial crisis. The results also reveal that borrowers paid higher interest rate spreads, had to post more collateral and the maturity was shortened during the crisis period. The reduction in interest rate spread and collateral depends on the protection of creditors’ rights. In countries where creditors’ rights are well protected, relationship loans pay less spread and are required to post less collateral than relationship loans in countries with weak protection of creditors’ rights.     

Foreign currency borrowing surrounding the global financial crisis: Evidence from Korea

We present a complete profile of firms’ foreign currency borrowing surrounding the 2007 global financial crisis. Employing extensive data from Korean firms during 2002–2012, we find that foreign currency borrowing is significantly related to firm attributes of export revenues, firm size, tangible assets and asset growth, as well as to macro-level factors. These results offer two important implications. First, macroeconomic factors alone cannot fully explain firms’ foreign currency borrowing. Second and more importantly, these firm attributes are indicative of a lower default probability and larger collateral value, which would not only facilitate borrowers’ access to foreign currency debt markets but also offer lenders a better protective cushion from possible loan defaults in the face of exchange rate changes and information asymmetry on borrowers’ credits. Period wise, asset-related firm attributes have more pronounced effects in the post- than pre-crisis period. We further show that banking regulations following the crisis effectively limit the access to foreign currency borrowing by Korean firms, most significantly by those belonging to large business groups.     

Relationship lending: A source of support or a means of exploitation?

Using a dataset from the State Bank of Pakistan containing each and every commercial loan generated in the economy from 2006 to 2013, we find that, on average, a longer relationship length is associated with lower risk premiums but higher collateral requirements. However, further examination paints a far more complex picture. The impact of relationship length on risk premiums and collateral varies substantially with the type of lender, as well as the type of borrower. We argue that conflicting empirical findings on relationship lending are the result of using datasets limited to certain types of borrowers or financial institutions.     

Financial Statements as Monitoring Mechanisms: Evidence from Small Commercial Loans

Using a data set that records banks’ ongoing requests of information from small commercial borrowers, we examine when banks use financial statements to monitor borrowers after loan origination. We find that banks request financial statements for half the loans and this variation is related to borrower credit risk, relationship length, collateral, and the provision of business tax returns, but in complex ways. The relation between borrower risk and financial statement requests has an inverted U‐shape; and tax returns can be both substitutes and complements to financial statements, conditional on borrower characteristics and the degree of bank–borrower information asymmetry. Frequent financial reporting is used to monitor collateral, but only for non–real estate loans and only when the collateral is easily accessible to lenders. Collectively, our results provide novel evidence of a fundamental information demand for financial reporting in monitoring small commercial borrowers and a specific channel through which banks fulfill their role as delegated monitors.     

Asset Liquidity,Moral Hazard,and Bank Loan Rescheduling

We analyze the bank's decision to reschedule or to foreclose on a loan in default and the borrower's decision to divert lender-financed assets to personal use, i.e., to consume the assets. We show that the debt of borrowers in financial distress that have substantial intangible or highly specialized assets—i.e., illiquid assets—is likely to be rescheduled. Alternatively, banks will likely foreclose on borrowers in distress that have assets that are difficult to monitor. It is the interaction of the asset's liquidity and the borrower moral hazard that helps determine the nature of the equilibrium. When the condition of the borrower upon default is observable, we find that suboptimal foreclosures are possible but reschedulings are always optimal; when the borrower's condition is private information, however, reschedulings may also be suboptimal. Additionally, borrowers whose lenders foreclose are more impaired then those whose debt is rescheduled. Finally, we show that randomization of the rescheduling/foreclosure decision by the bank and the decision to consume by the borrower may be optimal for particular assets.     

Attitudinal Asymmetries and the Lender-Borrower Relationship: Survey Results on Farm Lending in Shandong,China

This paper addresses the problem of social interactions and the lender-borrower relationship by measuring the disconnect between borrowers and lenders across a wide range of lending-related attributes. The degree by which lenders and borrowers connect disconnect depends on whether lenders’ and borrowers’ perceptions across these attributes are symmetric or asymmetric. We compare field survey results from 120 loan officers at Rural Credit Cooperatives (RCCs) in China’s coastal Shandong province, and pair them with an existing survey on identical questions to 394 farm households in the same region. Pairing lenders’ perception towards borrowers regarding RCC microcredit lending mechanism, against borrowers’ perception towards lenders and how themselves were perceived by lenders in the same regards, we observe on many dimensions a disconnect between them in the context of lenders’ “care” towards borrowers, loan rejection, memberships of RCC and group guarantee, lending concerns, cost of borrowing, reasons for default, credit rationing, and lending preferences. This research provides financial institutions with outreach mechanisms to borrowers, while also training lenders to borrowers’ sensitivities.     

PCAOB international inspection access and debt contracting: Evidence from American Depositary Receipt firms

We examine whether the Public Company Accounting Oversight Board’s (PCAOB’s) international inspection access affects the usage of accounting-based debt covenants in bank loan contracts of American Depositary Receipt (ADR) borrowers. We show that there is an increase in the use of financial covenants in debt contracts after the auditor of an ADR borrower becomes subject to PCAOB inspections. We also document that lenders increase the usage of financial covenants only in loans to ADR borrowers domiciled in countries with weak home country intuitions, and the increase is more pronounced for ADR borrowers from countries without a local auditor regulatory oversight body. These findings suggest that PCAOB regulatory oversight enhances the perceived credibility of accounting numbers for debt contracting and serves as a substitute for the weak monitoring of auditors for ADR borrowers domiciled in countries with weak country institutions.     

利率扭曲与资产泡沫

本文在一般均衡的框架下,分析实际利率被扭曲时资产价格的表现。主要贡献是,为中央银行刻意压低实际利率的政策建模,并分析它对资产价格的含义。我们发现,当中央银行调整货币政策目标、压低实际利率的时候,具有抵押价值的资产,其价格会上升,从而产生资产价格泡沫。利率被扭曲的后果可以表述为,金融体系不可能同时达到以下三个政策目标:持续压低的实际利率、自由的按揭贷款,以及合理的资产价格。     

The size and growth of microfinance institutions

We investigate the relationship between size (measured by total assets and number of active borrowers) and growth for a worldwide sample of microfinance institutions with different ownership forms (micro-banks, NGOs, cooperatives/credit unions and non-bank financial institutions) and commercial orientation (profit and not-for-profit) drawn from 120 countries over the period 2000 to 2014. Using a dynamic panel data model, we find little evidence that size confers growth advantages to microfinance institutions. We find some evidence that growth rates for credit unions and microfinance institutions with a not-for-profit commercial orientation present negative persistence. The variability of growth rates differs across the size distribution of microfinance institutions, and this result is consistent across commercial orientation and ownership form. Other factors affecting the growth of microfinance institutions include age (new microfinance institutions grow faster than young and mature counterparts), levels of bad debt, efficiency and regulation.     

Commitment, banks and markets

We examine how banks and financial markets interact with one another to provide liquidity to investors. The critical assumption is that financial markets are characterized by limited enforcement of contracts, and in the event of default only a fraction of borrowers’ assets can be seized. Limited enforcement reduces the fraction of assets that can be used as collateral and thus individuals subject to liquidity shocks face borrowing constraints. We show how banks endogenously overcome these borrowing constraints by pooling resources across several depositors, and increase the liquidity provided by financial markets.     

International capital flows and the boom-bust cycle in Spain

We study the joint dynamics of foreign capital flows and real activity during the recent boom-bust cycle of the Spanish economy, using a three-country New Keynesian model with credit-constrained households and firms, a construction sector and a government. We estimate the model using 1995Q1-2013Q2 data for Spain, the rest of the Euro Area (REA) and the rest of the world. We show that falling risk premia on Spanish housing and non-residential capital, a loosening of collateral constraints for Spanish households and firms, as well as a fall in the interest rate spread between Spain and the REA fuelled the Spanish output boom and the persistent rise in foreign capital flows to Spain, before the global financial crisis. During and after the global financial crisis, falling house prices, and a tightening of collateral constraints for Spanish borrowers contributed to a sharp reduction in capital inflows, and to the persistent slump in Spanish real activity. The credit crunch was especially pronounced for Spanish households; firm credit constraints tightened later and more gradually, and contributed much less to the slump.     

Securitized banking and the run on repo

The panic of 2007–2008 was a run on the sale and repurchase market (the repo market), which is a very large, short-term market that provides financing for a wide range of securitization activities and financial institutions. Repo transactions are collateralized, frequently with securitized bonds. We refer to the combination of securitization plus repo finance as “securitized banking” and argue that these activities were at the nexus of the crisis. We use a novel data set that includes credit spreads for hundreds of securitized bonds to trace the path of the crisis from subprime-housing related assets into markets that had no connection to housing. We find that changes in the LIB-OIS spread, a proxy for counterparty risk, were strongly correlated with changes in credit spreads and repo rates for securitized bonds. These changes implied higher uncertainty about bank solvency and lower values for repo collateral. Concerns about the liquidity of markets for the bonds used as collateral led to increases in repo haircuts, that is the amount of collateral required for any given transaction. With declining asset values and increasing haircuts, the US banking system was effectively insolvent for the first time since the Great Depression.     

Covenants and Collateral as Incentives to Monitor

Although monitoring borrowers is thought to be a major function of financial institutions, the presence of other claimants reduces an institutional lender's incentives to do this. Thus loan contracts must be structured to enhance the lender's incentives to monitor. Covenants make a loan's effective maturity, and the ability to collateralize makes a loan's effective priority, contingent on monitoring by the lender. Thus both covenants and collateral can be motivated as contractual devices that increase a lender's incentive to monitor. These results are consistent with a number of stylized facts about the use of covenants and collateral in institutional lending.     

Transactions Accounts and Loan Monitoring

We show that transactions accounts, by providing ongoing dataon borrowers’ activities, help financial intermediariesmonitor borrowers. This information is most readily availableto commercial banks, which offer these accounts and lendingtogether. We find that (1) monthly changes in accounts receivableare reflected in transactions accounts; (2) borrowings in excessof collateral predict credit downgrades and loan write-downs;and (3) the lender intensifies monitoring in response. Thisis evidence on a key issue in financial intermediation—thereis an advantage to providing deposit-taking and lending jointly.But this advantage may have fallen as the cost of communicationhas declined. (JEL G10, G20, G21)     

Collateralization,Bank Loan Rates,and Monitoring

We show that collateral plays an important role in the design of debt contracts, the provision of credit, and the incentives of lenders to monitor borrowers. Using a unique data set from a large bank containing timely assessments of collateral values, we find that the bank responded to a legal reform that exogenously reduced collateral values by increasing interest rates, tightening credit limits, and reducing the intensity of its monitoring of borrowers and collateral, spurring borrower delinquency on outstanding claims. We thus explain why banks are senior lenders and quantify the value of claimant priority.     

Do Business Borrowers Benefit from Bank Bailouts?: The Effects of TARP on Loan Contract Terms

We investigate benefits to business borrowers from bank bailouts, specifically the Troubled Asset Relief Program (TARP). Applying difference‐in‐difference methodology to loan‐level data, we find more favorable borrower contract terms in five dimensions, spread, amount, maturity, collateral, and covenants, suggesting increased credit supply at the intensive margin by bailed‐out banks. Findings are robust to dealing with endogeneity and other issues. Riskier borrowers benefit more, consistent with moral hazard exploitation. Small and unlisted borrowers benefit less, suggesting fewer benefits for financially constrained firms. Benefits accrue to both relationship and nonrelationship borrowers. Results contribute to the research and policy debates on bank bailouts.     

Asset scarcity and collateral rehypothecation

This paper introduces collateral rehypothecation, a widespread practice in derivatives, swaps, and repo markets, in a general equilibrium model with default. Rehypothecation frees up collateral because it allows lenders to resell or repledge assets pledged by borrowers. The risk that lenders will not return the asset, however, limits gains from rehypothecation. Still, when markets are contractually incomplete or decentralized, rehypothecation can achieve a superior use of scarce collateral. These results have implications for the repo market and suggest that limits to rehypothecation can cause price fragmentation.