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.