https://macropaperwarehouse.com/authors/chenyu-shan/Chenyu ShanHugo -- gohugo.ioen-ushttps://macropaperwarehouse.com/papers/outsourcing-bank-loan-screening-the-economics-of-third-party-loan-guarantees/https://macropaperwarehouse.com/papers/outsourcing-bank-loan-screening-the-economics-of-third-party-loan-guarantees/<p>Third-party loan guarantees—in which a fee-charging guarantor formally guarantees a bank loan and conducts its own due diligence on the borrower—are present in approximately 10% of Chinese bank loans and are required for most small and medium enterprise (SME) financing. This paper investigates their economic function using proprietary data from a large private loan guarantee firm and interviews with market participants. The paper systematically tests and rejects two leading alternative hypotheses: that guarantees circumvent interest rate caps via regulatory arbitrage (rejected because total loan payments never approach the cap in the data), and that guarantees primarily induce borrowers to self-select based on creditworthiness. The positive evidence points instead to a &ldquo;second level of delegation of loan evaluation&rdquo;: guarantors have private information about borrower quality beyond hard accounting data and collateral, screen bad loans effectively, and their pricing is consistent with the outsourced screening interpretation. This framework is analogous to Diamond&rsquo;s (1984) delegated monitoring, but prior to loan origination rather than after.</p>