Which risk–collateral channels affect loan management?

Abstract

Loan collateral assets are critical complementary bank credit instruments, pledged to a bank loan and intended to support and secure the enduring performance of this underlying credit facility. As a bank security mechanism, collaterals are considered an important mechanism to decrease credit rationing and credibly signal borrowers' quality. In an effort to investigate why the empirical relation between loan risk and collateral is sometimes positive and other times negative, this study provides a potential solution by examining the empirical relation between loan risk and the economic characteristics of collateral, each of which may be associated with the empirical dominance of different risk-collateral channels implied by economic theory. The relation between loan risk and collateral is examined by conducting two sets of empirical tests delineated by the loan risk premiums and ex-post nonperformance. Each set of tests explores the relation between the risk measure and the overall incidence of collateral, as well as the economic characteristics of the collateral pledges. Regressions include several control variables, including: firm, relationship, and loan variables, as well as fixed effects for region, bank, industry and time and sometimes interactions of firm, bank, and time fixed effects. Evidence is found supporting that for collateral overall, the "lender selection" channel is an important motivation for collateral pledges, and that the "loss mitigation" channel is a main determinant of risk premiums. Moreover, the "lender selection" channel dominates the "borrower selection" and "risk shifting" channels.