1. Bank of Italy Partial Credit Guarantee Schemes – Experiences and Lessons A joint conference by the World Bank, Rensselaer Polytechnic Institute, and the Journal of Financial Stability The World Bank, Washington DC March 13-14, 2008 Firms as Monitors of Other Firms: Mutual Loan Guarantee Consortia and SME Finance Francesco Columba, Leonardo Gambacorta, Paolo Emilio Mistrulli The usual disclaimer applies. The opinions are those of the authors only and in no way involve the responsibility of the Bank of Italy.

2. Bank of Italy The World Bank, Washington DCColumba, Gambacorta and Mistrulli - Firms as Monitors of Other Firms 2 Motivation In Europe two thirds of all jobs are provided by SMEs, this notwithstanding the literature shows that because of their opaqueness SMEs may encounter difficulties in accessing the credit market. Information asymmetries may be partially mitigated with collateral or relationship lending, but SMEs due to lack of collateral or of a long credit history may still find difficult to raise external finance. We analyse an alternative lending technology for SMEs, Mutual Loan Guarantee Consortia (MLGC), similar to group lending. With MLGC a group of SMEs with individual limited collateral are linked by a joint responsibility. Each SME contibutes to a guarantee fund that is used as collateral to loans granted to MLGC members. Italy is a telling case given the importance of MLGCs and SMEs. We aim to ascertain if MLGCs help to mitigate information asymmetries for SMEs.

3. Bank of Italy The World Bank, Washington DCColumba, Gambacorta and Mistrulli - Firms as Monitors of Other Firms 3 Outline MLGCs characteristics. Stylized facts on MLGCs. Effects of MLGCs on the cost of credit. Deeper into MLGCs: peer monitoring and external funds. Effects of MLGCs on the quality of credit. Conclusions.

4. Bank of Italy The World Bank, Washington DCColumba, Gambacorta and Mistrulli - Firms as Monitors of Other Firms 4 Italian Mutual Loan Guarantee Consortia characteristics MLGCs are registered at the Bank of Italy and are subject to prudential regulation only after a treshold of activity. The capital has to be more than 0.25 mln euro and at least 20% has to be subscribed by affiliated firms; third parties (public and alike) may subscribe capital. MLGCs ease SMEs access to credit in three ways: –post collateral drawed from guarantee funds deposited in a bank by affiliated firms and external bodies (usually monetary funds with a loan-to-guarantee ratio between 10 and 20); –selecting and monitoring firms; –negotiating collectively with banks financing conditions. MLGCs are grouped in 5 main federations along business sectors.

5. Bank of Italy The World Bank, Washington DCColumba, Gambacorta and Mistrulli - Firms as Monitors of Other Firms 5 Stylized facts for Italian MLGCs The MLGCs are around 1,000: their activity is stronger in Northern Italy, whereas half of the MLGCs are in the South. The average number of firms affiliated to a MLGC is 1,900. The guarantees provided by MLGCs are 8 billions euro for loans of 20 billions euro. 80% of guarantees are monetary, the rest are personal. 55% of Italian banks lent to SMEs affiliated to a MLGCs; 22% of large and medium banks, 46% of small banks. Typically a MLGC has a convention with 10 banks.

6. Bank of Italy The World Bank, Washington DCColumba, Gambacorta and Mistrulli - Firms as Monitors of Other Firms 6 Effects of MLGCs on the cost of credit Unique data-set from Italian Credit Register and Survey on Interest Rates with 263,000 SMEs that had a loan in 2005; 46,000 SMEs had a guarantee posted by a MLGC. Test of the effects of the posting of a MLGC guarantee on the interest rate paid on a bank loan to a SME. Benchmark model. Robustness. Beyond robustness.

7. Bank of Italy The World Bank, Washington DCColumba, Gambacorta and Mistrulli - Firms as Monitors of Other Firms 7 Benchmark model : effects of MLGC on interest rate MLGC dummy Bank-firm interest rate Sector dummy Artisan dummy Loan size South Dummy Bank dummy Single-lending dummy Real garantee dummy Total guarantees dummy

8. Bank of Italy The World Bank, Washington DCColumba, Gambacorta and Mistrulli - Firms as Monitors of Other Firms 8

9. Bank of Italy The World Bank, Washington DCColumba, Gambacorta and Mistrulli - Firms as Monitors of Other Firms 9 Robustness and beyond Robustness: –Controls for firms riskiness and bank entry; –Control for banks operating with at least a MLGC; –Controls for multiple lending and firm fixed effects; –Geographical fixed effects. Beyond robustness: –Cooperative banks: a MLGC guarantee raises the interest rate of the loan; –Control for selection bias: a treatment effect model to take into account the decision of a firm to join a MLGC.

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11. Bank of Italy The World Bank, Washington DCColumba, Gambacorta and Mistrulli - Firms as Monitors of Other Firms 11

12. Bank of Italy The World Bank, Washington DCColumba, Gambacorta and Mistrulli - Firms as Monitors of Other Firms 12 Deeper into MLGCs: peer monitoring and external funds Sub-sample of firms affiliated to a MLGC. Model of the firm’s choice of affiliation: Heckman procedure. Peer monitoring: the interest rate advantage of being affiliated with a MLGC raises up to a maximum and then declines coherently with a priori. External (public or alike) funds: reduction of interest rate advantage of the affiliation with a MLGC points to moral hazard problems.

13. Bank of Italy “Optimal” number of firms in MLGC for peer monitoring The World Bank, Washington DCColumba, Gambacorta and Mistrulli - Firms as Monitors of Other Firms 13

14. Bank of Italy The World Bank, Washington DCColumba, Gambacorta and Mistrulli - Firms as Monitors of Other Firms 14 Effects of MLGC on the quality of credit

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16. Bank of Italy The World Bank, Washington DCColumba, Gambacorta and Mistrulli - Firms as Monitors of Other Firms 16 Conclusions SMEs affiliated with a MLGC obtain credit at a lower interest rates than other SMEs, particularly where asymmetric information problems are most severe. Peer monitoring is beneficial to MLGC up to a treshold. External funds in MLGC might rise moral hazard problems. Firms affiliated to a MLGC are ex-post less risky. MLGCs seem to be a lending technology beneficial to SMEs.