The impact of credit reforms on bank loans and firm leverage around the world

• Published date: 01 November 2024
• Author: Halit Gonenc,Floris Jansen,Mario Hernandez Tinoco,Milos Vulanovic
• Date: 01 November 2024
• DOI: http://doi.org/10.1111/eufm.12477

DOI: 10.1111/eufm.12477

ORIGINAL ARTICLE

The impact of credit reforms on bank loans

and firm leverage around the world

Halit Gonenc

1

|Floris Jansen

2

|Mario Hernandez Tinoco

3

|

Milos Vulanovic

3

1

Department of Economics,

Econometrics and Finance, Faculty of

Economics and Business, University of

Groningen, Groningen, The Netherlands

2

Corporate Finance Department,

Houlian Lokey, Amsterdam,

The Netherlands

3

Finance Department, EDHEC Business

School, Roubaix Cedex 1, France

Correspondence

Halit Gonenc, Department of Economics,

Econometrics and Finance, Faculty of

Economics and Business, University of

Groningen, Nettelbosje 2, 9747 AE

Groningen, The Netherlands.

Email: h.gonenc@rug.nl

Abstract

This study examines how credit reforms impact

commercial bank loans and nonfinancial firms' debt.

Using two international samples for commercial banks

and nonfinancial firms from 2004 to 2019, we find that

global information‐sharing reforms encourage banks to

increase corporate loans, thus improving firm debt

financing, particularly in countries with weak creditor

rights. Legal rights reforms significantly boost corpo-

rate bank loans in emerging countries and enhance

firms' debt financing in developed countries. Our

findings suggest credit reforms positively impact firms'

financing; however, their effects on debt financing

supply and demand vary by economic development

level and the strength of creditor rights.

KEYWORDS

corporate governance reforms, creditor rights, emerging

countries, getting credit, legal rights, leverage, sharing credit

information

JEL CLASSIFICATION

G15, G21, G30, G32

Eur Financ Manag. 2024;30:2449–2502. wileyonlinelibrary.com/journal/eufm

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This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and

reproduction in any medium, provided the original work is properly cited.

© 2024 The Authors. European Financial Management published by John Wiley & Sons Ltd.

We would like to thank the editor, John A. Doukas, and the two anonymous referees for the valuable suggestions and

comments on an earlier version of this paper. We also benefited from the comments of Abe de Jong, Ettore Croci,

Kasper Roszbach and Dimitrios Gounopoulos, discussants at the 31st European Financial Management Association

2022 Annual Meeting in Rome.

1|INTRODUCTION

The ease of access to finance is one of the crucial preconditions for successful functioning of

the financial markets and economies (Demirgüç‐Kunt & Maksimovic, 1998;Fazzari

et al., 1988; Rajan & Zingales, 1998). The literature is still without a complete explanation of

corporations' financing choices. We investigate the effects of regulatory changes in credit

transactions, henceforth called credit reforms, on the proportion of corporate loans in

portfolios of commercial banks' total loans and on the level of firms' total debt ratio. Our

focus is on reforms improving secured transactions and credit information (CI)‐sharing

systems. To that end, we utilise World Bank Doing Business Reports at the country level.

1

Both strands of the access to finance literature separately show that secured transactions

regulations (De la Campa, 2011; Haselmann et al., 2010) and the establishment of credit

bureaus and registries (Bennardo et al., 2015;Brownetal.,2009;Peria&Singh,2014),

strengthens firms' access to credit. We identify the reforms' relative effects on the quality of

secured transactions and CI sharing on the variation in the amount of bank loans and firm‐

level debt. The second aim is to assess whether the relative importance of these effects

differs between developed and emerging countries as well as between countries with strong

and weak creditors protection.

The outcome of the reforms can be assessed from two perspectives: the supply and/or

demand of debt financing. Christodoulou et al. (2022) show that the evolving nature of

financial constraints is a function of both supply and demand side for investment. From a

supply‐side perspective, successful reforms should give rise to better conditions for lenders,

increasing thus their willingness to provide financing, which should be reflected by an

increase in the number of bank loans. On the one hand, improvements in the legal rights (LR)

regulating movable collateralfollowingcreditreformsresultinanincreaseinlendingby

banks for a given level of collateral (Calomiris et al., 2017; Campello & Larrain, 2016). On the

other hand, enhancements in CI‐sharing systems, which enable creditors to more accurately

assess the risks associated with borrowers, lead to a reduction in default rates and an

enlargement in loan portfolio size (Doblas‐Madrid & Minetti, 2013). Lenders will also be

more willing to extend larger loans on more favourabletermsbecauseoftheenhancedlegal

support and security in the debt collection process. Still, this mechanism could work

differently between developed and emerging markets because of institutional differences. For

instance, the reforms could strengthen powerful creditors in countries where creditor rights

were already substantial before their implementation. This could lead to nonfinancial firms

being less willing to depend on more powerful creditors, ultimately causing a decrease in

corporate loans.

From a demand‐side viewpoint, while the reforms may not create new investment

opportunities, firms in need of external financing can enjoy more favourable debt market

conditions and thus raise additional amounts of debt investing it in existing positive net

present value opportunities. Weak secured transaction regulations and limited CI sharing

1

Every year, the World Bank in its Doing Business report constructs indices that measure country‐level conditions of

access to credit. Credit reforms are implemented along two dimensions: secured transactions regulations and CI

sharing with a sole purpose of strengthening firms' access to debt financing. Secured transaction regulations ensure that

both borrowers and lenders receive sufficient legal support with respect to collateral and bankruptcy laws. CI‐sharing

systems aim to reduce the information asymmetry between borrowers and lenders, improving lenders' ability to assess

the creditworthiness of borrowers effectively.

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are significant constraints to developing well‐functioning credit markets. Therefore,

expanding the use of movable assets as collateral and improving creditors rights relative

to secure transactions on the one hand, and reducing information asymmetry between

borrowers and lenders on the other, should increase firms' access to credit.

Previous studies have examined the importance of LR or information sharing in explaining

the level of debt solely from a supply‐side perspective. Our objective is to disentangle the effects

of the two types of credit reforms by examining both the supply‐side and demand‐side

perspectives. We address the existing gap in the literature by providing empirical evidence that

encompasses both the effects of LR and information sharing. The information provided by the

World Bank Doing Business data allows us to examine both the joint and relative effects of LR

and information systems on debt financing.

Secured transactions regulations and CI sharing both play essential roles in enabling

firms to access credit. However, their effectiveness may vary across countries.

Since secured transactions could be equally critical for firms in both developed and

emerging markets or in countries with weak or strong creditor rights, LR reforms are

particularly relevant across countries to increase firms' access to debt financing. On

the other hand, CI sharing enables creditors to access more accurate and comprehensive

information about firms. This advantage is particularly notable in countries where

creditors have weaker rights and in emerging economies, which tend to face greater

information asymmetry issues compared with developed countries. We design our

empirical framework to discern cross‐country differences, taking into account several

characteristics. Thus, this study expands upon previous empirical research that has either

focused on single‐country analysis or explored the separate effects of LR and CI on the

access of firms to credit.

To empirically examine our research questions, we identify 68 countries in Moody's

Analytics BankFocus by Bureau van Dijk and 69 countries from the World Bank Doing

Business Getting Credit score data. We build a database consisting of 77,337 commercial

bank‐year and 287,598 firm‐year observations from 2004 to 2019. Building upon this data

set, we analyse the supply and demand channels of financing across three distinct

windows: prereform, reform and postreform. This analysis is conducted exclusively on the

sample of countries that have undergone reform. We conduct an evaluation of annual

changes, firstly, during the first and second years immediately following a reform, and

second, over a span of 2 years subsequently labelled as “postreform,”compared against the

year preceding the reform. We find that the ratio of corporate loans to total loans increases

more and decreases less during the post‐LR and information‐sharing reforms periods,

respectively. Overall, the demand‐side results indicate that, in the postreform period, firm

leverage diminishes less for both types of reforms, suggesting a positive shift on the

demand side.

When contrasting emerging with developed countries, our findings show a significant

increase in bank loans after LR reforms in emerging countries. Conversely, in developed

countries, firm leverage exhibits an escalation in the past‐reform years following the reform.

Furthermore, the proportion of corporate loans increases following information‐sharing

reforms in developed countries; however, this does not hold true for firm leverage. More

importantly, we demonstrate that the existing strength of creditor rights plays a more relevant

role in relation to information‐sharing reforms. In countries with weak creditor rights, both

bank loans and firm leverage increased following the reforms. This implies that information‐

sharing reforms are more beneficial to both the supply and demand sides when existing

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