Banks vs. Firms: Who Benefits from Credit Guarantees?

• Authors: Sergio Mayordomo, Victoria Vanasco and Alberto Martin.
• BSE Working Paper: 1389 | April 23
• Keywords: Debt Overhang , credit guarantees , liquidations
• JEL codes: G10,G18,G21,G28
• Debt Overhang
• credit guarantees
• liquidations

Governments often support private credit with guarantee schemes, compensating lenders for borrower defaults. Such schemes typically rely on banks to al- locate guarantees among borrowers, but how banks do so is not well understood. We study this in an economy where entrepreneurial effort, crucial for efficiency, is not contractible, creating a debt overhang problem. Credit guarantees can boost efficiency only if they lower repayment obligations, but their allocation by banks is subject to two distorsions. First, insofar as guarantees are scarce, banks extract rents from all allocated guarantees. Second, banks tilt the allocation of guarantees towards their less productive and highly-indebted borrowers, from whom they can extract even larger rents. As a result, the competitive equilibrium is inefficient. Our findings align with evidence from guarantees granted in Spain post-COVID.