Intended and Unintended Consequences of Government Credit Guarantee Programmes

In this chapter, we provide empirical evidence that the underwriting of private sector loans through a loan guarantee programme distorts the efficient allocation of bank credit. We exploit cross-sectional and time series variation in the availability of loan guarantees to entrepreneurial firms in the Netherlands after the financial crisis to examine the impact of loan guarantees on a large sample of individual borrowers. The introduction and posterior withdrawal of the programme had the intended effect on the number of loan applications. Firms eligible for loan guarantees applied for more loans relative to those that were not. However, loan guarantees reduced the incentives on banks to screen and monitor the quality of loans by reducing collateralized loans and making riskier loans. Our findings suggest that government guarantee programmes may have adverse effects on the screening incentives of banks.