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The Role of Guarantees in Bank Lending

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  • Pozzolo, Alberto Franco

Abstract

Guarantees play an important role in debt contracts. They alter the risk for the lender, transform borrowers' incentives and, possibly, 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 the same borrower, thus perfectly controlling for 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 if the borrower defaults), which 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, e.g. suretyships), which 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.

Suggested Citation

  • Pozzolo, Alberto Franco, 2004. "The Role of Guarantees in Bank Lending," Economics & Statistics Discussion Papers esdp04021, University of Molise, Department of Economics.
  • Handle: RePEc:mol:ecsdps:esdp04021
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    More about this item

    Keywords

    Bank loans; collateral; guarantee;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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