Secured Lending and Borrowers' Riskiness

Abstract

This paper investigates the relationship between secured lending and borrowers' riskiness. First it builds a theoretical model showing that banks may find optimal to cover higher credit risk by requiring a guarantee and simultaneously charging higher interest rates. Second, it finds empirical support for the predictions of the model, showing that banks normally require guarantees on loans that are likely to be riskier, because they are larger and they are granted to borrowers of smaller size, less capitalized, and with multiple banking relationships. It also provides evidence that that another important set of characteristics that make it more likely that a bank loan will be secured is the availability for the borrower of assets that can be posted as collateral. Third, it shows that interest rates on secured loans are higher than on unsecured loans, confirming that guarantees are indeed required to ex-ante riskier borrowers and that their presence is not sufficient to completely offset their higher riskiness.