Destroying collateral: asset security and the financing of firms

Abstract

Posting collateral encourages credit provision under the assumption that lenders can appropriate the pledged assets in case of default. When institutions work imperfectly, though, banks discount the value of effective collateral, thereby reducing lending volume. This process has been described in US states with difficult foreclosure procedures, but here we show that it also matters for poor countries after a violent conflict, when collateralizable assets have a heightened probability of being destroyed. We use firm-level data on loans in Sub-Saharan Africa to show that to get a loan, firms in countries with recent conflict need to pledge additional collateral. While some OLS offer supporting evidence, the effect is larger and more precisely estimated when we use quantile regressions to focus on the subgroup of firms that face tougher collateral requirements, which suggests that this effect is heterogeneous within countries. This mechanism is a novel channel that relates peace to economic growth and convergence through financial markets.

Keywords:

• mortgage
• political risk
• pledge-ability
• social conflict
• economic recovery
• peace dividend

JEL Classification:

• G33
• G21
• K42

Acknowledgements

Authors acknowledge the valuable academic conversations with Dani Rodrik and Marcel Fafchamps. We also acknowledge valuable discussions in the field with Nicole Kekeh and Chiara Selvetti, along with anonymous executives of African banks and entrepreneurs in 2009, which were the seminal motivation for the more systematic analysis we undertake here. Only the authors are responsible for the content expressed in this article.

Notes

¹ Berman et al. (2013) theoretically model the relationship between rebellion and investment, empirically finding a negative correlation between investment and violence along with a positive correlation between changes in those variables. They claim that investment attracts rebels who seize part of profits, which in turn discourages further investment. Collier and Duponchel (2013) use firm-level data from Sierra Leone to show that conflict harms firms through loss of human capital when operations are disrupted and skills atrophy. Without disagreeing with those channels, our effort is to highlight a different effect: collateral destruction. We investigate the way that conflict interacts with the inherent risks of finance caused by asymmetric information and moral hazard, regardless of expected return.

² At the macroeconomic level, Malamud and Assane (2013) show that Sub-Saharan Africa has not only low growth, but also low convergence. Chaudhuri and Srivastava Sr (1999) shows that domestic fundamentals in Africa could be behind the limited traction of capital inflows to that region.

³ Of course, there are limits to collateral, as pointed out by Stiglitz and Weiss (1981).

Additional information

Funding

A preliminary portion of this research was funded by the British Department for International Development as part of a Growth Diagnostics in 2009 [grant number 40012991].