Does Collateral Reduce Overdues? A Regression Discontinuity Approach

There is long-standing theoretical debate on the role of collateral in …nancial markets. There is no satisfactory evidence of the causal relationship (if any) between the amount of collateral required and the subsequent probability of overdues. We analyze an exogenous change in the number of cosigners required as collateral on small loans in South India. Our regression discontinuity approach reveals that increasing the number of cosigners reduces overdues –the e¤ect is large and signi…cant. Our results support the idea that collateral provides borrowers with incentives to repay but contradicts models in which collateral (1) is purely a hedge against default risk (2) sorts between high and low risk borrowers and (3) makes lenders lazy in their screening e¤orts. JEL Codes: O16, D82, G21