Credit risk, owner liability, and bank loan maturities during the global financial crisis

• Author: Fábio Dias Duarte,Ana Paula Matias Gama,Mohamed Azzim Gulamhussen
• DOI: http://doi.org/10.1111/eufm.12239
• Published date: 01 June 2020
• Date: 01 June 2020

Eur Financ Manag. 2020;26:628–683.wileyonlinelibrary.com/journal/eufm628

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© 2019 John Wiley & Sons Ltd.

DOI: 10.1002/eufm.12239

ORIGINAL ARTICLE

Credit risk, owner liability, and bank loan

maturities during the global financial crisis

Fábio Dias Duarte

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Ana Paula Matias Gama

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Mohamed Azzim Gulamhussen

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1

Politécnico do Porto, Escola Superior de

Tecnologia e Gestão & CIICESI,

Felgueiras, Portugal

2

Universidade da Beira Interior & NECE,

Covilhã, Portugal

3

ISCTE‐IUL Instituto Universitário de

Lisboa, Lisboa, Portugal

Correspondence

Ana Paula Matias Gama, Universidade da

Beira Interior & NECE, Estrada do

Sineiro –Polo IV, 6200‐209 Covilhã,

Portugal.

Email: amatias@ubi.pt

Funding information

FCT (ISCTE‐IUL: UID/GES/00315/2013;

PTDC/IIM‐FIN/7188/2014; UBI:UID/

GES/04630/2019; PTDC/EGE‐OGE/

31246/2017)

Abstract

We relate credit risk and owners’personal guarantees to

bank loan maturities during the global financial crisis.

The findings, which remain robust to reverse causality,

show that firms rated as low risk, with a strong

relationship with the bank, whose owners provided

personal guarantees and with large loan sizes obtained

longer maturities. Banks with larger nonperforming

loans provided loans with shorter maturities. Firms with

low‐and high‐risk ratings that provided owners’

personal guarantees obtained longer maturities. These

findings shed additional light on the relationship

between risk and loan maturities and the role of

personal guarantees in reducing information asymme-

tries.

KEYWORDS

banks, financial crisis, government policy and regulation, small firm

financing

JEL CLASSIFICATION

D82, G01, G18, G20

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The authors thank the Editor Professor John Doukas and the anonymous referees for their insightful and constructive

recommendations. Authors and institutions are listed in alphabetical order. The views expressed in this paper are those

of the authors and do not necessarily represent the views of the institutions with which they are affiliated. The authors

acknowledge financial, research and administrative support from the FCT (ISCTE‐IUL: UID/GES/00315/2013; PTDC/

IIM‐FIN/7188/2014; UBI:UID/GES/04630/2019; PTDC/EGE‐OGE/31246/2017).

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INTRODUCTION

The financing of small firms became a matter of policy interest during the global financial crisis

(financial crisis) as the failure of these firms could trigger a wave of bankruptcies and

unemployment, further endangering the recovery of ailing economies. There was particular

interest in Europe as many countries rely on small firms to drive the economy that, in turn,

relies on banks rather than their underdeveloped capital markets for lending (Krivogorsky,

2011; Niskanen & Niskanen, 2006).

At the time of the crisis, monetary authorities designed quantitative easing programs aimed

at smoothing economic recovery, and financial authorities designed policies aimed at

facilitating access to bank loans by small firms and reducing their failure rates. While

policymakers, scholars, and practitioners continue to take great interest in the effectiveness of

these programs and policies, there is still insufficient knowledge about how bank loan

maturities that were not part of any specific policy were determined during the financial crisis

(European Central Bank [ECB], 2010).

A number of studies show that loan maturities matter to both firms and banks. For firms,

shorter maturities restrict long‐term capital expenditures (González, 2015) and increase tension

due to regular renegotiating to roll over the loans and their terms (Bartoli, Ferri, Murro, &

Rotondi, 2013). For banks, (shorter) loan maturities facilitate and increase the efficiency of

monitoring (Berlin & Mester, 1992) and reduce the minimum capital required by regulators and

supervisors (Kirschenmann & Norden, 2012).

The determination of bank loan maturities in theory is addressed within the context of credit

rationing with imperfect information (Stiglitz & Weis, 1981). Loan markets may be rationed as

banks may consider not only the terms of the contract, such as maturities and riskiness of firms,

but also how the loan terms might subsequently affect adverse selection and moral hazard.

Studies in this vein predict loan maturities as being either a monotonic upward sloping function

of risk in which low credit risk firms will have shorter maturities and high credit risk firms will

have longer maturities (Flannery, 1986), or a nonmonotonic function of risk in which both low‐

and high‐risk firms will have shorter maturities (Diamond, 1991). The empirical literature that

tests the relation between credit risk and loan maturities shows mixed findings, however. In the

United States, Scherr and Hulburt (2001)

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and Berger, Espinosa‐Vega, Frame, and Miller

(2005)

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find a positive relation between credit risk and loan maturities, but Ortiz‐Molina and

Penas (2008)

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find they have a negative relation. These differing findings may be linked to the

fact that the original theories that relate credit risk to loan maturities were developed for market

debt and not bank loans; alternatively, the survey data used in Scherr and Hulburt (2001),

Berger et al. (2005), and Ortiz‐Molina and Penas (2008), for example, are average responses of

firms. In Europe, Magri (2010) and Kirschenmann and Norden (2012) find a more consistent

negative relation between credit risk and loan maturities in Italy (1993–2000) where the

enforceability of contracts is poor; and Germany (2005) where firms have high bargaining

power.

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The distinct findings for the United States and Europe may be explained by their

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In the data provided by the 1987 and 1993 National Survey of Small Business Finance (NSSBF).

2

In the data provided by the Federal Reserve’s 1997 survey of bank lending terms.

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In the data provided by the 1993 NSSBF.

4

In one related line of inquiry, firm governance may also determine corporate debt maturity (Li & Zhang, 2019). In another related line of inquiry, short‐term

debt may lead to lower stock price crashes (Dang, Lee, Liu, & Zeng, 2018).

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institutional contexts, more specifically, the market emphasis in the United States vs. bank

emphasis in Europe.

None of the studies in the United States and Europe look at bank loan maturities during

the global financial crisis, which is widely acknowledged as a unique laboratorial context to

test finance theories (Abreu & Gulamhussen, 2013) and inform post‐crisis reforms (Clare,

Fethi, Gulamhussen, & Pozzolo, 2016). We aim to fill this gap with this paper. Studying the

crisis context is particularly interesting. For example, the original theories predict that low

credit risk firms would prefer shorter maturities as they would have no concerns about

interest rate or liquidity changes in order to roll over their loans. But the crisis context

involved significant uncertainties regarding interest rate policy and the supply of bank

loans. How firms responded to these uncertainties has not yet been addressed in the

literature.

During the financial crisis, many banks in Europe required owners of small firms to pledge

personal guarantees to access loans and set terms (Bhimani, Gulamhussen, & Lopes, 2014;

2018).

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Unlike business collateral where firms’owners are liable up to the amount of collateral

that they post, personal guarantees amplify the owners’liability to an unlimited extent.

Business collateral limits the owners’downside risk and incentivizes shirking and risk‐shifting.

Personal guarantees do not limit owners’downside risk. Personal guarantees provided by

owners commit them to plowing additional equity into their firms in the case of distress. Such

commitments reduce information asymmetries (Diamond, 1991; Flannery, 1986), signal

creditworthiness (1997), and incentivize effort and prudence (Bester, 1985). These guarantees

were widely used by banks in Europe, largely facilitated by the following: heavy dependence of

small firms on intermediation for their financing requirements rather than mediation through

capital markets that inhibits the substitution of bank debt by market debt or equity; judicial

systems that involve significant transaction costs for firms to pledge business assets as

guarantees to banks; legal limitations in the repossession of business assets; and markets that do

not clear second‐hand business assets easily (Krivogorsky, 2011). However, researchers have not

given sufficient attention to this issue.

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In this paper, we first develop and test hypotheses that link bank loan maturities to firm

and bank characteristics, contract terms, and macroeconomic economic conditions. For

hard information, we relate the credit ratings of firms to loan maturities with the aim of

assessing whether banks use longer maturities for low‐risk firms and shorter maturities for

high‐risk firms. For soft information, we relate the bank–firm relationship to maturities of

loans with the aim of assessing whether banks use longer maturities for firms about which

they are better informed. For contract terms, we relate owners’personal guarantee to loan

maturities of loans with the aim of assessing whether this commitment increases loan

maturity; and loan size to loan maturities with the aim of assessing whether larger loans

have longer maturities. For the balance sheet quality of the lending bank, we relate

nonperforming loans to maturities with the aim of assessing whether impaired loans on the

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Bhimani et al. (2014) and Duarte et al. (2018) study the role of owners’personal guarantees in predicting defaults in bank loans to small firms during stable and

unstable economic situations.

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Notable exceptions include studies by Voordeckers and Steijvers (2006, Belgium) and Ortiz‐Molina and Penas (2008, United States). Both distinguish the roles

of business collateral and owners’personal guarantees in small firm financing. Voordeckers and Steijvers (2006, Belgium) focus on the factors that determine

the use of business collateral and owners’personal guarantees. Ortiz‐Molina and Penas (2008) focus in particular on the roles of collateral and guarantees

(alongside risk and bank borrower ties) in the determination of loan maturities of small firms in the United States. The authors use survey data to first estimate

a model with both business collateral and personal guarantees in which the latter is not significant, and then estimate models for business collateral and

personal guarantees separately.

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