The Uniqueness of Short-Term Collateralization
The author finds evidence that lines of credit secured by accounts receivable are associated with business borrowers with a high risk of default. While an unsecured short-term loan is repaid from the borrower's future cash flow, a loan secured...
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| Format: | Policy Research Working Paper |
| Language: | English en_US |
| Published: |
World Bank, Washington, DC
2013
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| Subjects: | |
| Online Access: | http://documents.worldbank.org/curated/en/2001/02/1000481/uniqueness-short-term-collateralization http://hdl.handle.net/10986/15743 |
| Summary: | The author finds evidence that lines of
credit secured by accounts receivable are associated with
business borrowers with a high risk of default. While an
unsecured short-term loan is repaid from the borrower's
future cash flow, a loan secured by accounts receivable (a
unique form of "inside" collateral) is repaid from
previously generated and observed sales (the borrower's
trade credit terms to its customers). Consequently, lenders
that secure accounts receivable are most concerned with the
credit risk of the borrower's customers and the
borrower's ability to continue to generate new sales. A
stylized theoretical model demonstrates that the value of a
secured line-of-credit loan in minimizing contracting costs
is associated with the borrower's business risk and the
quality of the borrower's customers. Empirical tests on
a sample of publicly traded U.S. manufacturing firms find
that firms with secured line of credit loans are observably
riskier and have fewer expected growth opportunities. The
author's findings suggest that observably riskier
borrowers can borrow more on a secured than on an unsecured
basis. The results highlight the important role of secured
letters of credit in providing liquidity to risky,
credit-constrained firms that might not have access to
external financing through other channels. |
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