THE ROLE OF SECURED CREDIT IN SMALL-BUSINESS LENDING

The traditional perspective holds that large firms in our economy use unsecured credit and small firms use secured credit. Existing scholars hip, however has provided little explanation of that pattern. In a rec ent article, I attributed the use of unsecured credit by large firms t o the limited capacity of secured credit to lower the lending costs of creditworthy companies. This al-ride uses data from a dozen interview s with small-business bankers to explain the small-business half of th at lending pattern. To the extent small-business lenders require secur ed credit, they do so largely for one significant benefit: secured cre dit allows small-business lenders to obtain a credible commitment that borrowers will refrain from excessive future borrowing. Secured credi t provides little in the way of liquidation value, because the assets of small businesses tend to have low liquidation values. Similarly, it does little to improve the borrower's incentives, because the lender can accomplish the same goal by taking a guaranty from the borrower's principal. As it happens, however much small-business borrowing is uns ecured. I identify four circumstances that explain that fact: the rela tively high transaction costs of secured debt; the declining enforceab ility of constraints on future lending (brought on by the ready availa bility of credit-card debt); the ambiguous value of constraints on fut ure lending; and technological developments in credit-scoring and earl y-warning systems that dramatically reduce lending costs and risks. I argue that those developments presage a marked shift of small-business lending from secured debt to unsecured debt.