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Deposits and relationship lending

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Author Info
Mitchell Berlin
Loretta J. Mester

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Abstract

The authors empirically examine the hypothesis that access to deposits with inelastic rates (core deposits) permits a bank to make contractual agreements with borrowers that are infeasible if the bank must pay market rates for its funds. Access to core deposits insulates a bank's costs of funds from exogenous shocks, allowing the bank to insulate its borrowers against exogenous credit shocks. Using a large sample of loans from the Survey of the Terms of Bank Lending, the authors find that when they control for competitive conditions in loan markets, banks funded more heavily with core deposits provide more smoothing of loan rates in response to exogenous changes in aggregate credit risk. This suggests that a distinctive feature of bank lending is that firms and banks form multiperiod lending relationships, in which loans need not break even period by period. It also partially explains the declining share of bank loans (or near substitutes for bank loans) in credit markets. As banks have increasingly been forced to pay market rates for an increasing share of their funds, multiperiod relationship lending has become increasingly less feasible and bank loans have lost some of their comparative advantage over securities. The authors' results suggest that access to core deposits is one of the foundations of relationship lending.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 96-18/R.

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Date of creation: 1997
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Handle: RePEc:fip:fedpwp:96-18

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Keywords: Bank deposits ; Bank loans;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. James, Christopher, 1996. " Bank Debt Restructurings and the Composition of Exchange Offers in Financial Distress," Journal of Finance, American Finance Association, vol. 51(2), pages 711-27, June. [Downloadable!] (restricted)
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  8. Leonard I. Nakamura, 1993. "Recent research in commercial banking: information and lending," Working Papers 93-24, Federal Reserve Bank of Philadelphia.
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  11. Petersen, Mitchell A & Rajan, Raghuram G, 1995. "The Effect of Credit Market Competition on Lending Relationships," The Quarterly Journal of Economics, MIT Press, vol. 110(2), pages 407-43, May. [Downloadable!] (restricted)
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  12. Loretta J. Mester & Leonard I. Nakamura & Micheline Renault, 1998. "Checking accounts and bank monitoring," Working Papers 98-25, Federal Reserve Bank of Philadelphia. [Downloadable!]
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  13. Sharpe, Steven A, 1990. " Asymmetric Information, Bank Lending, and Implicit Contracts: A Stylized Model of Customer Relationships," Journal of Finance, American Finance Association, vol. 45(4), pages 1069-87, September. [Downloadable!] (restricted)
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  14. Keeley, Michael C, 1990. "Deposit Insurance, Risk, and Market Power in Banking," American Economic Review, American Economic Association, vol. 80(5), pages 1183-1200, December. [Downloadable!] (restricted)
  15. John H. Boyd & Mark Gertler, 1994. "Are banks dead? or, are the reports greatly exaggerated?," Proceedings, Federal Reserve Bank of Chicago, issue May, pages 85-117.
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  16. Berger, Allen N & Udell, Gregory F, 1995. "Relationship Lending and Lines of Credit in Small Firm Finance," Journal of Business, University of Chicago Press, vol. 68(3), pages 351-81, July. [Downloadable!] (restricted)
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  20. Black, Fischer, 1975. "Bank funds management in an efficient market," Journal of Financial Economics, Elsevier, vol. 2(4), pages 323-339, December. [Downloadable!] (restricted)
  21. Petersen, Mitchell A & Rajan, Raghuram G, 1994. " The Benefits of Lending Relationships: Evidence from Small Business Data," Journal of Finance, American Finance Association, vol. 49(1), pages 3-37, March. [Downloadable!] (restricted)
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  27. Kashyap, Anil K. & Stein, Jeremy C., 1995. "The impact of monetary policy on bank balance sheets," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 42(1), pages 151-195, June. [Downloadable!] (restricted)
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  28. Sean Becketti & Charles Morris, 1992. "Are bank loans still special?," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 71-84. [Downloadable!]
  29. Bhattacharya Sudipto & Thakor Anjan V., 1993. "Contemporary Banking Theory," Journal of Financial Intermediation, Elsevier, vol. 3(1), pages 2-50, October. [Downloadable!] (restricted)
  30. Mitchell Berlin, 1996. "For better and for worse: three lending relationships," Business Review, Federal Reserve Bank of Philadelphia, issue Nov, pages 3-12. [Downloadable!]
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  32. Berger, Allen N. & Udell, Gregory F., 1990. "Collateral, loan quality and bank risk," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 21-42, January. [Downloadable!] (restricted)
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  33. Billett, Matthew T & Flannery, Mark J & Garfinkel, Jon A, 1995. " The Effect of Lender Identity on a Borrowing Firm's Equity Return," Journal of Finance, American Finance Association, vol. 50(2), pages 699-718, June. [Downloadable!] (restricted)
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