Many existing loans have soured, causing lenders to tighten credit terms on new lending. Meanwhile, borrowers have complained — and policymakers have openly worried — that lenders are refusing sound loans. New theories about lending and about loan contracts emphasize the difficulties lenders face in ensuring repayment of their loans. According to these theories, the collateral for a loan is not just a back-up source of repayment if the borrower defaults; collateral is also crucial for inducing payments from borrowers who can make them.

This article appeared in the July/August 1991 edition of Business Review.

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