Collateral Requirements of SMEs: Evidence from Less Developed Countries

Access to credit markets, in terms of both the availability and the cost of financing, strongly affects the growth of businesses. Given their dependence on banks for external capital, Small and Medium Enterprises SMEs are particularly exposed to banks’ loan conditions. The main goal of our paper was to investigate whether collateral requirements on loans extended to SMEs set in less developed countries refer mainly to firm–specific or market–specific characteristics. We observe that, rather than firm–specific variables, country–specific variables are more important in determining both the presence of collateral in loan contracts and the collateral-to-loan-value ratios. The strongest evidence of our paper addresses the importance of asymmetric information between borrowers and lenders. In countries where lenders have better information about borrowers, both the probability of the presence of collateral and the degree of that collateral decrease in loan contracts. Accordingly, collateral serves as a tool to resolve asymmetric information problems regarding the borrower’s quality.