Ebook The effects of mutual guarantee consortia on the quality of bank lending
Small and Medium Enterprises (SMEs) encounter often problems in financing their investment projects because, due to their opaqueness and short credit history, banks’ have a scarce ability in assessing their merit of credit. Informational asymmetries in the selection and monitoring process of SMEs traditionally hampers the overall amount of credit granted by banks to small firms and increase the amount of collateral (Petersen and Rajan, 1994, Berger and Udell, 2006).
In response to such problems, in the early 50s in North Eastern Italy emerged a peculiar financial intermediary, the Mutual Guarantee Consortium (MGC), specifically targeted to lever on the pooled financial and productive resources of a group of small firms to gain collectively better credit conditions and greater resources from the banking system.
A contractual scheme emerged to address the asymmetric information problem afflicting lending contracts with the SMEs under which banks lend individually to each firm of a group of borrowers linked by a joint responsibility for the loan. This contract design is very helpful in mitigating asymmetric information because every firm of the group is better informed than banks about other members’ characteristics and behavior. Thus, the members accepting a joint responsibility for a loan convey a good signal to banks about their creditworthiness. Moreover, under this kind of lending technology, group members agree to share the loss in the case of default by an affiliated firm being therefore motivated to monitor each other.
Another reason for this contractual scheme to be successful in improving credit market access for SMEs is that, notwithstanding each firm suffers individually of a lack of collateral, by pooling their resources the firms can provide the lender, on top of the standard collateral which may be used on a rotating basis, with the social capital embedded in the group.
The aim of this paper is to analyze whether Italian MGCs improve the quality of bank lending. In Italy each member of the consortium contributes to a guarantee fund from which is drawn collateral posted to loans granted by banks to MGC members. This consortium is therefore an institutional device that puts under the same responsibility a group of small firms that need bank lending but individually have a limited collateral capacity. Since members are mostly part of the same local community, peer-monitoring is in place and our hypothesis is that it significantly reduces moral hazard.
SMEs are quite widespread in the old continent. The 2005 European Commission data state that there are more than 20 millions firms in Europe providing employment for more than 140 million people and that over two thirds of all jobs are provided by SMEs. Italy according to the last national census of 2001 had four millions firms with less than 50 employees representing therefore a case in favor of the relevance of the MGCs for the economy given the weight of the SMEs on the overall number of firms.
According to the 2005 data by the European Mutual Guarantee Association, in the European Union there are more than 1.4 million of SMEs affiliated to a MGC. The diffusion of MGCs is particularly relevant in Germany, France, Spain and Italy. Italian MGCs represent, however, the largest component of the European mutual guarantee sector accounting for almost 40 per cent of the total outstanding volume of guarantees to SMEs.
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