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CEP discussion paper
Collateral Value and Forbearance Lending
Nan-Kuang Chen and Hsiao-Lei Chu
December 2003
Paper No' CEPDP0603:
Full Paper (pdf)

JEL Classification: E44; E51; G3

Tags: collateral value; forbearance lending; government guarantee.

We investigate the foreclosure policy of collateral-based loans in which the endogenous collateral value plays a crucial role. If creditors are able to commit, then the equilibrium arrangement is more likely to feature forebearance lending by specifying a lower level of liquidation (or roll over all of the loans) relative to the expost efficiency criterion for each realization of the interim signal. The key is that collateral value may drop too low when banks call in loans by auctioning off borrowers¿ collateral and this makes clearing up non-performing loans less attractive. We attribute the banks¿ leniency as we have observed in Japan during the 1990s to an equilibrium arrangement where banks can commit due to either relationship banking or an implicit lenderborrower contract, such as the arrangement under Japan¿s main-bank system.