EFFECTS OF RELATIONSHIP AND CREDITOR RIGHTS ON LOAN CONTRACTING

Abstract

Some countries have stronger laws to protect creditor’s interest than do other countries. Some borrowers have prior relationship with their lenders while others do not. Do differences in creditor protection laws and relationship existence affect loan contracting? If yes, how does it affect? We attempt to answer these questions with a large sample of loans to borrowers in 61 countries during the 1980 to 2008 period. We find that repeated borrowing from the same lender translates into an approximate 6.5 basis point lowering of loan spreads. We also find that relationship loans are also less likely to be secured by collateral. The results also support the view that stronger creditor rights result in more favourable loan contracting. Banks charge lower spreads on loans and less likely to require collateral from borrowers in countries where creditor rights are well protected. These effects are both statistically significant and economically large, even after controlling for the endogeneity of the relationship formation. Generally, we find significant benefits from borrowing in a strong creditor rights country and from relationship lenders. However, we do not find any benefits of informal finance, suggesting that formal changes in legal rules as well as enforcement for credit would be highly beneficial to weaker creditor rights countries in terms of cost of debt financing.