Empty Creditors: How Public Credit Guarantees Impair Loan Restructuring

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Speaker: Professor Cem Demiroğlu, Koç University

About the seminar

This paper examines an unintended consequence of public credit guarantees (PCGs): they significantly impair banks’ incentives to restructure troubled loans. Using comprehensive loan-level data from Turkey’s 2017 credit guarantee program, we find that guaranteed loans are 25 percentage points more likely to end in default rather than restructuring.

Our identification strategy exploiting within-firm variation reveals that even loans to the same borrower face dramatically different restructuring prospects based on guarantee status. The effect is stronger when banks have higher guarantee coverage and weaker as they approach portfolio-level loss caps, consistent with moral hazard driving the results. Banks protected by guarantees engage in less monitoring, slower intervention, and less thorough rehabilitation of troubled borrowers.

This distortion in creditor behaviour has significant real effects, with PCG borrowers experiencing higher liquidation rates, larger declines in sales, assets, employment, and business relationships following distress. We find strong evidence that moral hazard – not information frictions – drives these results, as a 2018 reform requiring restructuring attempts before guarantee claims reduced the PCG-default relationship by approximately 40%. Our findings reveal how government guarantees can transform banks into ’empty creditors’ who maintain control rights but bear limited exposure to default outcomes, leading to inefficient liquidations and highlighting important policy trade-offs in credit guarantee program design.

Speaker bio

Cem Demiroğlu is a Professor of Finance at Koç University and a member of the Turkish President’s Council of Economic Advisors. He serves on the Board of Borsa İstanbul and previously was founding president of Türk Reasürans A.Ş. He is also a founding member of Enstitü Sosyal, an independent policy think tank focused on education, social and economic reform.

His research lies at the intersection of corporate finance and financial intermediation, with a focus on information asymmetries, incentive conflicts, and the design of financial contracts. His recent work focuses on the impact of government interventions in credit markets. His articles have been published in leading academic journals such as the Journal of Finance, Journal of Financial Economics, Review of Financial Studies, and Management Science.

He holds a Ph.D. in Finance from the University of Florida and has held visiting positions at the London Business School, University of Florida, and Bocconi University.

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