March 2010 – Hyderabad ( India ) SMEs and Banks : Investigating the Link between Trust and the Pledging of Personal Collateral

Research on relationship lending focuses attention on economic factors which influence the relationships between SMEs’ owners/managers and banks but no previous work has focused on the role of trust. Trust is expected to reduce agency costs, the perceived credit risk and, thus, influence credit availability and credit terms. Trustworthiness is associated with three attributes of SME owner managers’ namely; ability, benevolence and integrity. It is hypothesised that lending managers’ assessment of the trustworthiness of SME owner managers affects the request of personal collateral from bank when credit is provided. Trustworthiness is hypothesised as negatively associated with personal collateral in the form of personal guarantees and personal assets. Using the data obtained from a survey of lending managers from banks in North East Italy we test this relationship. Research methods include construction of control variables and a vector of trustworthiness factors based on the data collected on a random sample of 535 borrowing firms. Results from the regression analysis show some evidence that the line of credit of firms enjoying high level of trust are less collateralised with entrepreneurs’ personal assets even if the significance of both the specification and trust is low. Our findings support the view found in earlier literature on trust that personal collateral pledging is decided at the beginning of the relationship and then such a decision is not changed by the bank. Some implications of these results and future research are discussed.