It is a widely held perception, although empirically contentious, that credit rationing is an important phenomenon in the UK small business sector. In response to this perception the UK government initiated a loan guarantee scheme (SFLGS) in 1981. In this paper we use a unique dataset comprised of small firms facing a very real, and binding, credit constraint, to question whether a corrective scheme such as the SFLGS has, in practice, alleviated such constraints by promoting access to debt finance for small credit constrained firms. The results broadly support the view that the SFLGS has fulfilled its primary objective.

Theories of loan contracting in the presence of asymmetric information highlight the key role of collateral in mitigating against credit rationing. However, theory also allows for the use of collateral by ‘bad’ borrowers in order to receive better loan contract offers. In this study, we explore the extent to which collateral can affect the incidence of absolute loan denial and partial rationing associated with smaller loans than requested being offered. Using data from a large survey of UK small- and-medium enterprises, we find significant evidence on the negative effect of collateral. Our results also reveal important distinction between lines of credit and term loans, where the presence of collateral is associated with 3 % less term loan approved compared to overdraft. We argue that even the request (or offer) of collateral for a term loan indicates that either the bank or the firm believes it is a risky bet.