9th Symposium on Finance, Banking, and Insurance
Universität Karlsruhe (TH), Germany, December 11 - 13, 2002

Abstract

Collateral, Default Risk, and Relationship Lending:
An Empirical Study on Financial Contracting *

Ralf Elsas** and Jan Pieter Krahnen #

** CFS Center for Financial Studies, Frankfurt.
E­mail: elsas@stud.uni­frankfurt.de
# CFS Center for Financial Studies, Goethe­Universität Frankfurt and CEPR
E­mail: krahnen@wiwi.uni­frankfurt.de

This paper provides further insights into the nature of relationship lending by analyzing the link between relationship lending, borrower quality and collateral as a key variable in loan contract design. We used a unique data set based on the examination of credit files of five leading German banks, thus relying on in­ formation actually used in the process of bank credit decision­making and contract design. In particular, bank internal borrower ratings serve to evaluate borrower quality, and the bank's own assessment of its housebank status serves to identify information­intensive relationships. Additionally, we used data on work­ out activities for borrowers facing financial distress. We found no significant correlation between ex ante borrower quality and the incidence or degree of collat­ eralization. Our results indicate that the use of collateral in loan contract design is mainly driven by aspects of relationship lending and renegotiations. We found that relationship lenders or housebanks do require more collateral from their debtors, thereby increasing the borrower's lock­in and strengthening the banks' bargaining power in future renegotiation situations. This result is strongly supported by our analysis of the correlation between ex post risk, collateral and relationship lending since housebanks do more frequently engage in workout activities for distressed borrowers, and collateralization increases workout probability.