Loans , Interest Rates and Guarantees : Is There a Link ?

This paper aims at shedding light on the influence of guarantees on the loan pricing (banking interest rates), by focusing on three different types of customers: firms, producer households and consumer households. The relevance of guarantees in lending activity is widespread acknowledged, and their role is recognized in the New Basel Capital Accord (Basel II) that foresees a specific regulation for secured loans. While the existence of a positive relationship between interest rates and the riskiness of borrowers (in this paper approximated by bad loans) is well established in the literature, the role of guarantees is less clear. Economists’ instinct and conventional wisdom in the banking community would support the idea that secured loans are less risky and, therefore, should carry lower interest rates. However, some papers find an unexpected positive relationship between interest rates and guarantees (see, for example, Barro, 1976, Berger and Udell, 1990): “This result has two major implications: that secured loans are typically made to borrowers considered ex-ante riskier by banks, and that the presence of warranties is insufficient to offset such higher credit-risk” (Pozzolo, 2004). The higher interest rates applied to loans backed by guarantees may also be due to the effects of asymmetric information. On the one hand, banks might ask for guarantees when they need to distinguish ex-ante the risk of different types of borrowers (adverse selection). Alternatively, banks may use guarantees as an incentive mechanism to reduce the possibility of opportunistic behavior of borrowers after the transaction occurred (moral hazard). It is important to distinguish between real and personal guarantees. Personal guarantees are contractual obligations of a third party, and they act as if they were external collateral. However, they do not give the lender a specific claim on particular assets, and change the actions he could take in the case of the borrower’s bankruptcy. Consequently, only empirical analysis may help