Effects Of Collateral On Loan Repayment: Evidence From An Informal Lending Institution

ABSTRACT

We examine the effect of the collateral informal lenders use to ensure loan repayment. Specifically we measure how the use of movable and immovable assets affects loan repayment and delinquency rate, and assess the extent to which guarantorship and relationship-lending act as collateral to improve loan repayment. With a dataset of 835 individual borrowers drawn from an informal Tanzanian lending institution, we run descriptive and econometric models. The results suggest that movable assets increase the likelihood that borrowers perceived to be less creditworthy will obtain loans from informal sources and repay them. We also find a small proportion of customers to have pledged immovable assets as collateral when borrowing from informal lenders. The results also show the positive effect of referral, which implies that relationship lending and social collateral is key to increasing access to finance through informal lenders. Our results contribute to the advancement of economic theory, specifically in the ex-ante and ex-post-related literature.

KEYWORDS:

• Collateral
• loan repayment
• informal lending
• delinquency
• Tanzania

Notes

1. Informal finance is a broad concept that encompasses a wide range of financial activities and services that take place beyond the scope of a country’s formalized financial institutions and lie outside financial sector regulations (FinScope, 2013). In our case, informal finance is used to mean services offered by institutions offering select banking services but not recognized as official banks, as well as services offered at the ad hoc level with no formal financial sector regulation. In particular, we focus on a legally registered institution that comes under no objections from the central bank simply because it is not regulated by the banking regulations.

2. Adequate collateral implies physical assets or equity that the lender can sell if the borrower defaults (Pozzolo & Elinaudi, 2014).

3. The context in which social collateral is used in this paper refers to third-party personal commitments and obligations to facilitate the recovery of the loan (Pozzolo & Elinaudi, 2014).

4. This is according to the credit policy and loan contracts of the company from which the sample was drawn.