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Screening good borrowers: Evidence from the small business community

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Abstract

The current collapse of credit markets has left small and medium enterprises (SMEs) facing severe credit rationing. The practice of screening borrowers by risk level has become a paramount consideration for both lenders and firms. This paper represents the first empirical test of the screening role of loan contracts that consider collateral-interest margins simultaneously. For our empirical analysis, we use a unique data set composed of bank loans granted by 28 Spanish banks to SMEs. Our results suggest that by combining collateral appropriately with interest rate, borrowers with different risk levels are separated: high-risk borrowers accept loans without collateral and with high interest rates, whereas low-risk borrowers accept loans with real estate collateral and with low interest rates. Hence, we provide the first empirical evidence of the effectiveness of collateral as a screening mechanism, when it is adequately combined with interest rates

Suggested Citation

  • Comeig, Irene & Del Brio, Esther & Fern ndez, Matilde O., "undated". "Screening good borrowers: Evidence from the small business community," Working Papers "New Trends on Business Administration". Documentos de Trabajo "Nuevas Tendencias en Dirección de Empresas". 2010-06, Interuniversity Research Master and Doctorate Program (with a quality mention of ANECA) on "Business Economics", Universities of Valladolid, Burgos, Salamanca and León (Spain). Until 2008, Interuniversity Doctorate Program (with a quality mention of ANECA) “New trends in Business Administration”, Universities of Valladolid, Burgos, and Salamanca (Spain). Master en Investigación y Programa de Docto.
    • Handle: RePEc:ntd:wpaper:2010-06
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    Keywords

    Asymmetric Information; Collateral; Credit Risk; Incentive-Compatible Contracts; Screening Mechanisms;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • 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
    • L26 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Entrepreneurship

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