Estimating the relationship between collateral and interest rate: A comparison of methods

Andrea Bellucci,Alexander Borisov,Germana Giombini,Alberto Zazzaro

doi:10.1016/j.frl.2021.101962

Abstract

This paper uses a variety of estimation methods to explore the empirical relationship between interest rate and collateral requirements in bank loan contracts. Methods that do not allow for endogenous contract terms detect a positive reciprocal association between interest rate and collateral. Methods that allow for endogenous contract terms point to a strong positive effect of interest rate on collateral but the effect of collateral on interest rate is weaker. This highlights the importance of incorporating the endogenous nature of contract terms in empirical work.

Highlights

Extant theoretical work in the area of loan contracting usually models interest rate and collateral as interrelated components of the same contract
We estimate that an increase in Collateral of a standard deviation is associated with an increase in the interest rate of about 9 basis points
This represents a meaningful economic effect given that the mean value of Collateral is 19%

Summary

Introduction

Extant theoretical work in the area of loan contracting usually models interest rate and collateral as interrelated components of the same contract. We adopt a more comprehensive approach and explore several methods for the estimation of the empirical relationship between interest rate and collateral in bank loan contracts. Data and Outcome Variables We estimate the models of collateral and interest rate using a dataset of credit lines extended to a large number of Italian SMEs by a major Italian bank as of September of 2004 and 2006.

Results

Conclusion