Firms as monitor of other firms: mutual guarantee institutions and SME finance

A large body of literature has shown that small firms, due to their opaqueness, may find it difficult to access the credit market. Informational asymmetries may be mitigated by posting collateral or by building relationships with lenders (relationship lending). However, in some cases, due to a lack of collateral or of a long credit history, small enterprises may still find it very difficult to raise external finance unless alternative contracting schemes emerge. In particular, group lending or similarly micro-finance are examples of such alternative lending contracts. In this paper, we investigate the effect of mutual guarantee institutions (MGI) on loan interest rates. We argue that, similarly to group lending and micro-finance, firms affiliated to a MGI are linked by a joint responsibility for the loan providing MGI affiliates with peer monitoring incentives. Indeed, each MGI member contributes to the guarantee fund that is then posted as collateral to loans granted to MGI members. As a consequence, MGI willingness to post collateral signals firms creditworthiness to banks. The econometric analysis supports the hypothesis that these consortia improve lending conditions for small firms.