BIS report on mutual guarantee institutions and small business finance
13 October 2009
Small firms have little collateral and short credit histories and thus may find it difficult to raise funds from banks. The report shows that small firms affiliated with mutual guarantee institutions pay less for credit compared with non-MGI members.
A large body of literature has shown that small firms experience difficulties in accessing the credit market due to informational asymmetries. Banks can overcome these asymmetries through relationship lending, or at least mitigate their effects by asking for collateral. Small firms, especially if they are young, have little collateral and short credit histories, and thus may find it difficult to raise funds from banks. In this paper, it is shown how that even in this case, small firms may improve their borrowing capacity by joining mutual guarantee institutions (MGIs).
The empirical analysis shows that small firms affiliated with MGIs pay less for credit compared with similar firms which are not MGI members. This results in interest rates charged on loan contracts which are not backed by mutual guarantees. The findings are consistent with the view that MGIs are better than banks at screening and monitoring opaque borrowers. Thus, banks benefit from the willingness of MGIs to post collateral since it implies that firms are better screened and monitored.
© BIS - Bank for International Settlements
