Mitigating Information Asymmetries through Collateral Pledges

This study determines if small business collateral requirements differ between racial/ethnic and gender groups and how firm, loan, and market characteristics impact any differences in these terms. Previous literature establishes that Hispanics, Blacks, and females are considered riskier than their non-minority and male counterparts, receiving more loan denials and higher loan costs. Lenders mitigate asymmetric information by monitoring or influencing riskier borrowers through the use of non-price loan factors such as collateral requirements. Data from the Federal Reserve’s Survey of Small Business Finances is analyzed to determine whether lenders impose larger collateral requirements on minority and female small businesses as a way to monitor this group of borrowers. A Blinder-Oaxaca decomposition is used to demonstrate how variations in collateral requirements are influenced by identifying characteristics. Decomposition results show differences collateral requirements and much of the evidenced gap is attributed to differences in levels of banking competition in borrower markets, loan interest rates, and loan amounts.