Showing papers on "Collateral published in 2004"

Banks versus Venture Capital: Project Evaluation, Screening, and Expropriation

Abstract: Why do some start-up firms raise funds from banks and others from venture capitalists? To address this question, I study a model in which the venture capitalist can evaluate the entrepreneur's project more accurately than the bank but can also threaten to steal it from the entrepreneur. Consistent with evidence regarding venture capital finance, the model implies that the characteristics of a firm financing through venture capitalists are relatively little collateral, high growth, high risk, and high profitability. The model also suggests that tighter protection of intellectual property rights encourages entrepreneurs to finance through venture capitalists. SINCE 1980 THE U.S. VENTURE capital industry has grown dramatically. Venture capitalists are known to play a crucial role in incubating new firms by supplying them with equity capital. Banks, too, are an important source of funds for new firms. But banks seem slower than venture capitalists in meeting the financial needs of new firms. According to Ueda (2002), indicators of bank lending to small firms are constant or even fall after 1977, whereas venture capital investment is almost 100 times larger in 2001 than it was in 1977. To understand this trend in which venture capital financing has grown significantly relative to bank financing, I develop a simple model of the trade-offs involved between financing through a bank and through a venture capitalist. The bank is less informed than either the entrepreneur or the venture capitalist, and as a result must attempt to induce self-selection for the profitable entrepreneur, make use of collateral, and demand higher payments from the profitable entrepreneur in order to break even. On the other hand, when they meet, the venture capitalist and the entrepreneur become equally informed about the project, but the venture capitalist may be able to undertake the project

Collateral, type of lender and relationship banking as determinants of credit risk

Abstract: This paper analyses the determinants of the probability of default (PD) of bank loans. We focus the discussion on the role of a limited set of variables (collateral, type of lender and bank–borrower relationship) while controlling for the other explanatory variables. The study uses information on the more than three million loans entered into by Spanish credit institutions over a complete business cycle (1988–2000) collected by the Bank of Spain's Credit Register (Central de Informacion de Riesgos). We find that collateralised loans have a higher PD, loans granted by savings banks are riskier and, finally, that a close bank–borrower relationship increases the willingness to take more risk.

Determinants of Collateral

Abstract: This paper draws upon the theory of contracting under asymmetric information to postulate and test several hypotheses concerning the relationship between the use and amount of collateral in financial loans to firms, the risk profile of the borrower, business cycle and monetary conditions of the economy, strength of the lending relation between borrower and lender, competition in the credit market and expertise and preferences of the lender. The research takes advantage of a very large panel of data coming from the Credit Register that contains the whole population of loans granted every year from 1984 to 2002 by Spanish banks to firms (approximately two million loans). Important novelties of the paper are that the quality of the borrower is measured in terms of ex ante and ex post credit risk, that the association between credit risk of the borrower and the use of collateral is evaluated in different segments of the credit market (short-term, and long-term loans, and new and old borrowers), which are likely to present differences in the relative information advantage of the borrower over the lender, and that we also control for borrowers' idiosyncratic effects. The evidence confirms that the use of collateral is determined in a predictable, different way in each market segment.

Relationship Lending: A Survey of the Literature

Abstract: This paper reviews the recent literature on relationship lending First, the effect of relationship lending on firm value is examined in the context of the event studies investigating the impact of announcement of bank loans on stocks of the borrowing firms Second, the effects on funds availability, loan rates, and collateral requirements are appraised Third, the evidence on the impact of the length of the relationship, multiple bank relationships, and distance from the lender are assessed Fourth, the effect of bank consolidation on relationship banking and the role of de novo banks are discussed Finally, the effects of deregulation and technology on community banks are examined The evidence indicates that relationships increase funds availability and reduce loan rates The evidence on the direction and magnitude of the length of relationships is mixed and multiple relationships reduce the value of any single borrower lender relationship Small banks can maintain the advantages of relationship banking in spite of technological changes

Competitive Equilibrium in the Credit Market under Asymmetric Information

Abstract: We study a competitive credit market equilibrium in which all agents are risk neutral and lenders a priori unaware of borrowers' default probabilities. Admissible credit contracts are characterized by the credit granting probability, the loan quantity, the loan interest rate and the collateral required. The principal result is that in equilibrium lower risk borrowers pay higher interest rates than higher risk borrowers; moreover, the lower risk borrowers get more credit in equilibrium than they would with full information. No credit is rationed and collateral requirements are higher for the lower risk borrowers.

Credit cycles redux

Abstract: Theoretical studies have shown that under unorthodox assumptions on preferences and production technologies, collateral constraints can act as a powerful amplification and propagation mechanism of exogenous shocks. We investigate whether or not this result holds under more standard assumptions. We find that collateral constraints typically generate small output amplification. Large amplification is obtained as a “knife-edge” type of result.

Social networks and collateral health effects

Abstract: Since a patient or a clinical trial participant is connected to other people through social network ties, medical interventions delivered to a patient, quite apart from their health effects in that person, may have unintended health effects in others to whom he is connected. The cumulative impact of an intervention is therefore the sum of the direct health outcomes in the patient plus the collateral health outcomes in others (figure). These effects, in both the patient and in their social contacts, might be positive or negative. Doctors, trialists, patients, or policy makers might see reason to take them into account when choosing treatment or evaluating benefit. Figure 1 Collateral health effects of medical care in social networks. In the conventional perspective on medical care, the benefits and costs of health care are judged by the way in which they help to achieve a direct, intended outcome in a patient. However, ... For example, treating depression in parents may increase their propensity to vaccinate their children, thereby saving children's lives. Replacing a hip or preventing a stroke may mean that a person is better able to care for his spouse, thus improving her health. Delivering a weight loss intervention to one person may trigger substantial weight loss in that person's friends. Giving a patient superior end of life care may decrease the stressfulness of the patient's death and thus decrease his spouse's propensity to die during bereavement.1 These collateral health consequences that accrue to others are known to social scientists as externalities. They are similar to the increase in value a person's neighbour may see if the person refurbishes his property; the person himself derives no benefit from the neighbour's windfall, even though he has invested resources and created this new value. Here, however, we are considering not monetary externalities but rather specifically health externalities. Moreover, in the healthcare arena patients may derive value from such effects. For example, since 89% of patients feel that a good death involves not burdening family,2 patients might prefer hospice care over standard terminal care if they felt it offered health benefits to their loved ones.1 When the cost-benefit assessment is made by policy makers with a collective viewpoint, all the downstream costs and benefits of health care accruing to a group might be relevant, and the argument in favour of accounting for collateral effects might be even more compelling than that perceived by individual doctors or patients. From a societal perspective the assessment of the cost effectiveness of medical interventions might change substantially if the benefits of an intervention are seen as including the collateral positive effects and the costs as including the collateral negative effects. Such a concern for collateral effects could, however, also lead to unexpected results. For example, preventing a death from heart attack, which is clearly desirable from the individual's perspective, may mean that we have to forego the motivation that would otherwise have accrued to others to whom the patient is connected to improve their own health habits. Another provocative implication is that policy makers might value socially connected individuals—such as married people—more when it comes to health care since benefits might be multiplicative in such people.3 We have scattered evidence supporting the plausibility and likely magnitude of such collateral health effects. The most well known example is that the death of one spouse increases the risk of death in the other.4,5 Moreover, morbidity in one spouse can contribute to morbidity in the other—for example, via caregiver burden.6 Breast cancer in one woman may motivate others to whom she is connected to have mammography.7 Exercise or smoking cessation in one person may prompt numerous others to behave similarly. Conversely, there may be epidemics of disorders such as obesity, alcoholism, suicide, or depression that might spread in a peer to peer fashion.8 Even loose social connections can be conduits for such effects; cancer in a celebrity, for example, may motivate many people not known to the index case to undergo cancer screening or choose particular treatments.9,10 Vaccinating some people in a population may cause others (for example, immunocompromised people) to become sick through the spread of the vaccine virus or, conversely, to remain well through the effect of herd immunity. The existence of collateral health effects and the fact that each individual may be connected to numerous others, including relatives, friends, neighbours, and co-workers, implies developments in research and policy. To explore such effects, new datasets and methods will be needed. Most prospective cohort studies and randomised controlled trials today include only individuals who are followed to observe outcomes. Some social science and epidemiological cohort studies do ask individuals about the health status of their spouse or some other social contact, but only a few (for example, the US health and retirement survey) actually include the spouse or other social contacts in the study cohort. Developing datasets with such features and measurements is necessary to understand fully collateral health effects. Collecting information about the various contacts of people enrolled in clinical trials or epidemiological studies may represent an extension to study design similar to the extension in the 1990s of including cost effectiveness analyses as a standard feature of clinical trials. Network phenomena are receiving increased attention in fields as diverse as engineering, biology, and sociology,11,12 but they are also relevant to health and medicine. Networks have emergent properties not explained by the constituent parts and not present in the parts. Understanding such properties requires seeing whole groups of individuals and their interconnections at once. The existence of social networks means that people and events are interdependent and that health and health care can transcend the individual in ways that patients, doctors, policy makers, and researchers should care about.

Liquidity, Default and Crashes: Endogenous Contracts in General Equilibrium

Abstract: Introducing default and limited collateral into general equilibrium allows for a theoery of endogenous contracts, ..

Disequilibrium in the UK corporate loan market

Abstract: In the last decade, a debate has resurfaced about whether financial constraints stemming from asymmetric information and incentive problems play an important role in propagating monetary policy shocks. This paper investigates the monetary transmission mechanism in the UK and its impact on the availability of bank credit to small and medium size firms. The empirical specification is based on a disequilibrium model that allows for the possibility of transitory credit rationing. Sample firms are classified endogenously into ‘borrowing constrained’ and ‘borrowing unconstrained’. The analysis of credit rationing takes into account not only firm specific variables, but also important macroeconomic factors such as the prevailing monetary conditions and the stage of the business cycle. We find that (i) firms’ assets play an important role as collateral in mitigating borrowing constraints; (ii) during periods of tight monetary conditions corporate demand for bank credit increases, whereas the supply of bank loans is reduced; (iii) to avoid bank credit rationing smaller companies increase their reliance on interfirm credit; (iv) the proportion of borrowing constrained firms is significantly higher during the recession years of the early 1990s than at other times.

A microeconometric analysis of credit rationing in the Polish farm sector

Abstract: The objective of this paper is to investigate credit rationing of Polish farms. The analysis is based on cross-section survey data and motivated by a microeconomic farm household model. The results suggest that more than 40 per cent of borrowers experience pronounced credit rationing by rural banks. Credit-rationed households display an average marginal willingness to pay for short-term credit of 209 per cent net of principal. Furthermore, household variables have a significant effect on output supply. Demographic characteristics and a lack of collateral are major determinants of credit rationing. Public interest rate subsidisation contributes little to alleviate rationing of farms. Copyright 2004, Oxford University Press.

The US Current Account Deficit and Economic Development: Collateral for a Total Return Swap

Abstract: We argue that a chronic US current account deficit is an integral and sustainable feature of a successful international monetary system. The US deficit supplies international collateral to the periphery. International collateral in turn supports two-way trade in financial assets that liberates capital formation in poor countries from inefficient domestic financial markets. The implicit international contract is analogous to a total return swap in domestic financial markets. Using market-determined collateral arrangements from these transactions we compute the collateral requirements consistent with recent foreign direct investment in China. The data are remarkably consistent with such calculations. The analysis helps explain why net capital flows from poor to rich countries and recent evidence that net outflows of capital are associated with relatively high growth rates in emerging markets. It also clarifies the role of the reserve currency in the system.

How much Does Household Collateral Constrain Regional Risk Sharing? (joint with Stijn Van Nieuwerburgh) (updated February 2006)

Abstract: We construct a new data set of consumption and income data for the largest US metropolitan areas, and we show that the covariance of regional consumption and income growth varies over time and in the cross-section. In times and regions where collateral is scarce, regional consumption growth is about twice as sensitive to income growth. Household-level borrowing frictions can explain this new stylized fact. When the value of housing relative to human wealth falls, loan collateral shrinks, borrowing (risk-sharing) declines, and the sensitivity of consumption to income increases. Our model aggregates heterogeneous, borrowing-constrained households into regions characterized by a common housing market. The resulting regional consumption patterns quantitatively match those in the data.

Does poor legal enforcement make households credit-constrained?

Abstract: This paper analyzes the relation between the quality of the legal enforcement of loan contracts and the allocation of credit to households, both theoretically and empirically. We use a model of household credit market with secured debt contracts, where the judicial system affects the cost incurred by banks to actually repossess the collateral. The model shows that the working of the judicial system affects both the probability of being credit-constrained and the equilibrium amount of debt. In the empirical part, we test our predictions using data on Italian households and on the performance of Italian judicial districts. Controlling for household characteristics, unobserved heterogeneity at judicial district level and aggregate shocks, we document that an increment in the backlog of trials pending has a statistically and economically significant positive effect on the household probability of being turned down for credit. Furthermore, we show that moving a household from the high-cost judicial district (in southern Italy) to the low-cost judicial district would reduce his probability of being credit-constrained by 50% on average, other things being equal.

The Role of Guarantees in Bank Lending

Abstract: 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.

The Effect of Conforming Loan Status on Mortgage Yield Spreads: A Loan Level Analysis

Abstract: ∗∗∗ ∗∗∗ The magnitude of the effect of government-sponsored enterprise purchases on primary mortgage market rates has been a difficult research question with differing data and competing methodologies producing varying results. Here we present a new approach using loan level data and controlling for credit risk differentials between conforming and nonconforming loans. Our method also addresses econometric problems of endogeneity and sample selection bias. We find that conforming loans have yield spreads about 5.5% lower compared to other loans on a risk-adjusted basis. This is lower than previous estimates appearing in the literature. Lenders in the primary mortgage market originate a range of contracts, many of which are then sold in the secondary market, either to the governmentsponsored enterprises (Fannie Mae and Freddie Mac, hereafter the GSEs 1 )o r pooled as collateral for private label mortgage-backed securities. Other loans are retained in portfolio or sold on a whole-loan basis. Loans vary in coupon, size, term, collateral and, of course, credit quality. Based on business strategy and risk preferences, together with information obtained during the underwriting process, and considering rules and price signals from the secondary market, lenders make a hold-versus-sell decision. What factors determine that decision, and what is the overall effect on rates in the primary market? These questions are among many that are crucial to evaluating the role of the GSEs, whose special status in the economy generates both costs and benefits (Sanders 2002). GSE purchases provide liquidity to primary lenders and perhaps ∗ ∗∗ ∗∗∗ � ∗∗∗

The Shackled Continent: Africa's Past, Present and Future

Abstract: Two fifths of African nations are at war, AIDS has lowered life expectancy to as young as 40 years old, investment is almost impossible due to lack of collateral and foreign aid has had very little effect on the poor. This title provides a history and commentary on the enigma of modern Africa.

The US Current Account Deficit and Economic Development: Collateral for a Total Return Swap

Abstract: We argue that a chronic US current account deficit is an integral and sustainable feature of a successful international monetary system. The US deficit supplies international collateral to the periphery. International collateral in turn supports two-way trade in financial assets that liberates capital formation in poor countries from inefficient domestic financial markets. The implicit international contract is analogous to a total return swap in domestic financial markets. Using market-determined collateral arrangements from these transactions we compute the collateral requirements consistent with recent foreign direct investment in China. The data are remarkably consistent with such calculations. The analysis helps explain why net capital flows from poor to rich countries and recent evidence that net outflows of capital are associated with relatively high growth rates in emerging markets. It also clarifies the role of the reserve currency in the system.

Microfinance: Where do we Stand?

Abstract: Economies are built upon people buying and selling, lending and borrowing. The beauty of the market is that, when it works well, sellers are matched to buyers and lenders are matched to worthy borrowers. But when the market does not work well, goods go unsold and promising investment projects go unfunded. We understand why markets fail - the economics of information provides rigorous underpinnings for why credit markets, in particular, are so problematic.1 The challenge has been to move from diagnosis to prescription. The challenge is particularly great in poorer regions, where individuals may have workable ideas and relevant experience but lack collateral. Even a £100 loan can make a difference to a small-scale shopkeeper or craftsperson in countries like Nepal or Uganda, but formal sector banks have steered clear, focusing instead on larger loans to better-established, wealthier clients.

Asset Price Shocks, Financial Constraints, and Investment: Evidence from Japan

Abstract: This paper examines investment spending of Japanese firms around the "asset price bubble" in the late-1980s and makes three contributions to our understanding of how stock valuations affect investment. First, corporate investment responds significantly to nonfundamental components of stock valuations during asset price shocks; fundamentals matter less. Clearly, the stock market is not a 'sideshow'. Second, the time series variation in the sensitivity of investment to cash flow is affected more by changes in monetary policy than by shifts in collateral values. Finally, asset price shocks primarily affect firms that rely more on bank financing, and not necessarily those that use equity markets for financing. Only the investment of bank-dependent firms responds to nonfundamental valuations. In addition, the cash flow sensitivity of bank-dependent firms with large collateral assets decreases when asset prices become inflated, but increases dramatically when asset prices collapse and monetary policy tightens.

Transactions accounts and loan monitoring

Abstract: The authors provide evidence that transactions accounts help financial intermediaries monitor borrowers by offering lenders a continuous stream of data on borrowers’ account balances. This information is most readily available to commercial banks, but other intermediaries, such as finance companies, also have access to such information at a cost. Using a unique set of data that includes monthly and annual information on small-business borrowers at an anonymous Canadian bank, the authors find a significant relationship between loans becoming troubled and the number of prior borrowings in excess of collateral. Since the bank monitors the value of collateral (defined as accounts receivable plus inventory) at high frequency through the transactions account of the borrower, this unique access to useful information gives banks an advantage over other lenders. The authors also find that banks more intensively monitor loans that have a higher number of violations of the collateral limit. ; This paper substantially revises and supersedes the paper "Checking accounts and bank monitoring".

Microfinance: Does It Hold Its Promises? A Survey of Recent Literature

Abstract: Poverty alleviation has been the main target of developmental projects world-wide. However, only a few ideas have stirred so much attention in the last two decades as that of the provision of microfinance through specialised institutions. This paper provides a survey of the vast literature that has developed in this field. Though most of the evidence and literature on the subject appears self-praising, nonetheless there is much more to the concept than one can imagine. The establishment of microfinance institutions (MFIs) world-wide for the provision of collateral free loans to the poor through mechanisms and instruments not known to normal commercial banks has set new milestones in the field of financial services. With 900 million households in the less developed countries left without any access to formal financial services, this might just be the key to address market failures in the financial landscape.

Market Imperfections, Investment Flexibility, and Default Spreads

Abstract: This paper develops a structural model that determines default spreads in a setting where the debt’s collateral is endogenously determined by the borrower’s investment choice, and a demand variable with permanent and temporary components. We also consider the possibility that the borrower cannot commit to taking the valuemaximizing investment choice, and may, in addition, be constrained in its ability to raise external capital. Based on a model calibrated to data on office buildings and commercial mortgages, we present numerical simulations that quantify the extent to which investment flexibility, incentive problems, and credit constraints affect default spreads.

The Agency Problems, Firm Performance and Monitoring Mechanisms: the evidence from collateralised shares in Taiwan

Abstract: This paper indicates that there is an inverse relationship between collateralised shares and firm performance. We further show that this inverse relationship exists only in conglomerate firms. These findings imply that agency problems resulting from shares used as collateral by boards of directors are more serious in conglomerate firms than in non-conglomerate firms. Moreover, we provide evidence that monitoring by institutional investors, creditors and dividend policy can effectively reduce the agency problems of shares used as collateral and thus can improve firm performance.

Testing for Adverse Selection and Moral Hazard in Consumer Loan Markets

Abstract: This paper explores the significance of unobservable default risk in mortgage and automobile loan markets. I develop and estimate a two-period model that allows for heterogeneous forms of simultaneous adverse selection and moral hazard. Controlling for income levels, loan size and risk aversion, I find robust evidence of adverse selection, with borrowers self-selecting into contracts with varying interest rates and collateral requirements. For example, ex-post higher-risk borrowers pledge less collateral and pay higher interest rates. Moreover, there is strongly suggestive evidence of moral hazard such that collateral is used to induce a borrower's effort to avoid repayment problems. Thus, loan terms may have a feedback effect on behavior. Also, higher-risk borrowers are more difficult to induce into exerting effort, explaining the counter-intuitive result that higher-risk borrowers sometimes pay lower interest rates than observably lower-risk borrowers.

Lending to Small and Medium-Sized Firms: Is There an East-West Gap in Germany?

Abstract: The financing of small and medium-sized firms is important for the catching-up of the East German to the West German economy since reunification. We explore whether it is restricted by unfavorable bank loan terms, using bank-survey data on lending decisions to small and medium-sized firms. A comparison of the terms of lending between the former East German and West German states yields a lending gap given by higher loan prices and collateral requirements in East Germany. This gap can be explained by differences in credit risks and lending strategies of banks.

Bank Loans to Distressed Firms: Cronyism, bank governance and economic crisis

Abstract: Loans to financially distressed firms contributed to Korea's 1997 crisis. Possible explanations for these loans include bank's better inside information on borrowing firms, crony lending, and financial institutions' (FI) moral hazards (FIs' poor governance). We examined 6474 non-financial firms' capital structures during 1990-2000. Firms in distress or with higher leverage growth rates tended to show lower expost ability to pay debt, and lower return on assets, suggesting that lending decision is not based on inside information. Even after controlling for available collateral, size and industry effects, distressed firms with large business group (chaebol) affiliation showed the highest borrowing growth rate without proportionately more short-term loans, suggesting crony lending or government guarantees. Distressed firms with FI affiliation showed a higher leverage growth rate, consistent with the related lending argument. Distressed non-chaebol firms without FI affiliation also showed higher leverage growth rates and with proportionately more short-term loans. However, their ex-post performance was lower. These results show that banks lent to these small firms without affiliation to chaebols nor FIs despite the lack of external pressure, suggesting poor governance at the FIs.

Housing Collateral, Consumption Insurance and Risk Premia: an Empirical Perspective (joint with Stijn Van Nieuwerburgh), forthcoming Journal of Finance

Abstract: In a model with housing collateral, the ratio of housing wealth to human wealth shifts the conditional distribution of asset prices and consumption growth. A decrease in house prices reduces the collateral value of housing, increases household exposure to idiosyncratic risk, and increases the conditional market price of risk. Using aggregate data for the US, we flnd that a decrease in the ratio of housing wealth to human wealth predicts higher returns on stocks. Conditional on this ratio, the covariance of returns with aggregate risk factors explains eighty percent of the cross-sectional variation in annual size and book-to-market portfolio returns. Keywords: Asset Pricing, Risk Sharing.