Screening good borrowersEvidence from the small business community

Resumen

The current collapse of credit markets has left small and medium enterprises (SMEs) facing severe credit rationing. The practice of screening borrowers by risk level has become a paramount consideration for both lenders and firms. This paper represents the first empirical test of the screening role of loan contracts that consider collateral-interest margins simultaneously. For our empirical analysis, we use a unique data set composed of bank loans granted by 28 Spanish banks to SMEs. Our results suggest that by combining collateral appropriately with interest rate, borrowers with different risk levels are separated: high-risk borrowers accept loans without collateral and with high interest rates, whereas low-risk borrowers accept loans with real estate collateral and with low interest rates. Hence, we provide the first empirical evidence of the effectiveness of collateral as a screening mechanism, when it is adequately combined with interest rates.