Credit Rationing

Following the argument developed by Stiglitz and Weiss (1981) we understand as credit rationing when relatively profitable projects doesn’t have access to financing and at the same time the rest of projects with equal apparent profitability does, or when the changes in interest rates or other credit variables are unable to eliminate the excess of demand of loans in the market for an specific group of companies or projects6.

A credit rationing as stated before can be the consequence of bankers and borrowers having different information about the same projects, situation known as ‘imperfect information, residual imperfect information or asymmetric information’ leading to the phenomenon known in economics as ‘adverse selection’ and ‘incentive effect’7. Focused in the SMEs sector Storey (1993) includes another four factors that are related with the rationing of credit: the high fixed cost of information research; the variety in credit conditions (interest rate, terms and other conditions) used by the banks to compete; the variety of attitudes, skills and motivations that entrepreneurs presents8; the high ‘mortality rate’ that SMEs presents.

This last four factors have directly/indirectly relation with the original two mentioned by Weiss and Stiglitz (1981).

In order to get a more clear understanding of the credit rationing effect, would be useful to describe the decision process that a banker applies pursuing the maximizing of benefits. In order to simplify we’ll assume that the banker takes decisions under free risk conditions in a competitive market and without imperfect information; finally we’ll consider the bankers as the only loan supplier.

This maximization implies that the banker has to assign the resources (compounded by the deposits obtained at the market interest rate and by his available equity) in between the borrowers trying to make equal expected returns (net of risk) from of each one of them. In the goods and services market where the information is accessible and abundant the pricing mechanism plays a superlative role determining the equilibrium price and eliminating any excess of demand, then the most profitable expected projects would pay higher interest rates crowding out the less profitable ones.

But in the ‘real market’ the bank has limited information (imperfect information), and limited control over the borrowers actions (incentive effect), leading to what is known as ‘Collateral and Limited Liability Theory’ in which the banks use collaterals as a way to reduce the risk of default and increase the return. This mechanism (with enormous implication in SMEs financing) by which the bank increases the liability of the borrower in case the project fails leads to different perceptions of the risk and return of the project from both parts: the borrower doesn’t take into account the losses of the bank in case of failure and the bank doesn’t take into account the profits of the borrower when the project success but only the pay back of the loan (also because it is not sure about the information). Then the expected return of the bank will depend on the risk perception that it has from each project in particular.

This risk perception depends as well on the particular conditions of each project and/or borrower, information that normally is very expensive and difficult to obtain (‘high fixed costs of information’ and ‘borrower attitudes’). Another effect of the increase in collaterals required by lenders is that it can stimulate a decrease on the risk aversion of the borrowers leading them to undertake riskier projects.

The interest rate that the borrower is willing to pay doesn’t represents a reliable measure of risk as the presence of asymmetric information impede the bankers to know the profit distribution of the project that indeed is known by the borrower.

Even more the increase in the cost of credit will reshape the investment portfolio of the bank in benefit of the most risky projects (and discouraging safer borrowers) because higher payoffs as these can better afford such increase, but in average have less probability of success. Nevertheless a situation can occur where the loan is denied due to wrong risk perception even with higher rates, then the rationing is via volume. This phenomenon is known as ‘adverse selection’. The other effect perceived is that borrowers could select more risky projects deviated from the original or manage the already financed one under risky circumstances not accepted by the bank in order to afford the increase in the cost of credit. This phenomenon is known as ‘incentive effect’.

The mentioned phenomena imply that the loan supply for a determined group of borrowers could not increase when the interest rate is increased, even when the offer is constant (Note figure 5 and Table 6 analyzed further).

In this way, keeping in mind the interest rates paid by other intermediaries and even under an excess of demand, the bank would not encourage the supply of loans since it doesn’t implies an increase in the expected return which could allow higher interest rates paid to the depositors in order to obtain larger deposits.

As Stiglitz and Weiss (1981) analyze, due to the credit rationing, among loan applicants who appear to be identical some receive a loan and others do not, even if they offered to pay a higher interest rate; or there are identifiable groups of individuals who with a given supply of credit are unable to obtain loans at any interest rate, even though with a larger supply of credit, they would9.

Considering this situation for the whole group of banks competing for deposits and trying to maximize benefits an equilibrium situation could be found in which the credit rationing exist: profitable projects/business at the interest rate in force in the market can not get access to financing even paying higher rates.

The possibility of this type of equilibrium increases with the risk dispersion of the projects as the asymmetric information increases too. Thus this probability is higher in between the SMEs sector due to the atomization observed by type of business. Finally the empirical evidence shows that this situation is less often when the availability of resources increases (i.e. due to a higher saving ratio of the economy or the financial system development). In this point we could make a parallelism with the size of the banking systems of different countries mentioned in the Framework section.

Credit rationing: Focusing in asymmetric information

From the factors mentioned in this work as potential originators of credit rationings one of the most accepted is the asymmetric information problem and this is in particular the functional aspect that we’re going to highlight as we consider it the main problem in the SMEs financing.

In some point the incidence of every factor is affected (or originated) by the lack of information or by the quality of the available one:

The ‘high fixed cost of information’ talks by himself about this problem: as in a great extent this costs are independent from the amount of the loan to grant then the smaller projects (in terms of money) will be more affected, thus this difficulty to reach economies of scale in the assignment of loan portfolio will discriminate a priori the smaller firms.

The ‘incentive effect’ has a direct relation with the information available about the evolution of the project (monitoring) throughout its “period of life”: the less the monitoring of the project the higher the probability that the borrower would deviate from the original objectives agreed.

The ‘variety in credit conditions’ is in part consequence of the diversity of business in between the SMEs sector, which is not a problem in it self but the difficulties to manage the information in a more effective way, forcing the banks to make a more segmented effort increasing the costs of evaluation and monitoring.

The ‘variety of attitudes’ is related with the incentive effect factor and of course either in this point the effort made by the lender has to be more segmented reducing the cost efficiency mentioned in the previous point.

The ‘high mortality rate’ of SMEs is part of the ‘intrinsic’ characteristics of this sector11 and in this aspect the decrease of the mortality not only depends on the information provided to the bank by the company in order to anticipate financial crisis situations but also the information that the company obtain (i.e. consultancy) and of course the commercial aspect of the business.

Asymmetric Information and concentration process

This section will be focused in the reshape of the financial system caused by the banking concentration process after the Tequila Crisis, highlighting the vanishing of financial intermediaries that had been typically oriented to SMEs financing and thus had closer information.

The following analysis has a limitation with respect to the period of time included, because the effect of the mentioned vanishing can not be easily compared against the situation before the ’Convertibility Plan’ implementation in 1991. In the previous decade with periodically high inflation rates, a closed economy resting importance to competitiveness and an extremely inefficient financial system the cost of credit or even the access were not the main problems of the SMEs. At that time alternative sources of financing were used (that disappeared in the next period), like financing at negative interest rates provided by fiscal agencies and the liquation of salary costs associated to the inflation. The terms of financing were extremely short and the information presented by companies and individuals applying for a loan were more distorted due to the variability in the relative prices and the inflation, interest and exchange rates.

Something similar happened on the other side with the recurrent support of the BCRA to maintain the solvency of several institutions including public banks with large participation in the supply of loans, showing a paternalist behaviour more than a clear market functioning (The change in this policy was one of the reasons that explain several mergers and acquisitions in the next decade).

Said this our analysis about the concentration process will include only the decade of 1990 with starting point at the Convertibility Plan of 1991.