Abstract
AbstractWe develop hypotheses regarding the association between two types of creditor rights and bank loan losses. Contrary to prior research conclusions, bank lending risk is negatively associated with both restrictions on reorganization and the secured creditor being paid first. Using accounting disclosures, we develop novel empirical measures of the probability of default (PD) and loss given default (LGD) at the loan-portfolio level. Different types of creditor rights have differential effects pertaining to PD and LGD and exhibit significant intertemporal variation. We corroborate our cross-country findings using the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) shock to creditor rights.
Highlights
State-mandated creditor rights during bankruptcy protect creditor interests in the event of default and ensure the availability of debt capital
We argue that creditor-side effects will dominate under secured creditor is paid first (SECURED), leading to an increase in probability of default (PD)
We have argued that loss given default (LGD) is unequivocally reduced by enhancing creditor rights, especially SECURED, which reflects the secured creditor being paid ahead of nonsecured creditors, such as employees and the government, and REORG, which reflects the restrictions on reorganization by the borrower
Summary
State-mandated creditor rights during bankruptcy protect creditor interests in the event of default and ensure the availability of debt capital. One important article examining this issue is Houston, Lin, Lin, and Ma (2010), which concludes that stronger creditor rights can lead banks to make riskier loans, exacerbating the likelihood of financial crises. These conclusions regarding lending are not based on a bank-level examination of the loan portfolio but rather on an empirical proxy for overall bank risk (z-score). La Porta et al (1998) empirically document cross-country differences in bankruptcy codes and creditor protections by first constructing the widely used creditor rights index, which is an aggregation of the individual creditorprotection measures. La Porta et al (1998) empirically document cross-country differences in bankruptcy codes and creditor protections by first constructing the widely used creditor rights index, which is an aggregation of the individual creditorprotection measures. Djankov et al (2007) extend this panel to 129 countries and show that when creditors are better protected, there is greater credit in an economy, validating one of the principal findings within the theoretical literature
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