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Lines of Credit and Relationship Lending in Small Firm Finance

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Author Info
Allen Berger
Gregory Udell

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Abstract

This paper examines the role of relationship lending using a data set on small firm finance. The abilities to acquire private information over time about borrower quality and to use this information in designing debt contracts largely define the unique nature of commercial banking. Recently, a theoretical literature on relationship lending has appeared which provides predictions about how loan interest rates evolve over the course of a bank-borrower relationship. The study focuses on small, mostly untraded firms for which the bank-borrower relationship is likely to be important.

The authors examine lending under lines of credit (L/Cs), because the L/C itself represents a formalization of the relationship and the data are thus more "relationship-driven." They also analyze the empirical association between relationship lending and the collateral decision.

Using data from the National Survey of Small Business Finance, the authors find that borrowers with longer banking relationships pay a lower interest rate and are less likely to pledge collateral. Empirical results also suggest that banks accumulate increasing amounts of this private information over the duration of the bank-borrower relationship.

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Paper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 94-11.

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Date of creation: Mar 1994
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Handle: RePEc:wop:pennin:94-11

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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. Diamond, Douglas W, 1991. "Monitoring and Reputation: The Choice between Bank Loans and Directly Placed Debt," Journal of Political Economy, University of Chicago Press, vol. 99(4), pages 689-721, August. [Downloadable!] (restricted)
  2. Mark Carey S. & Stephen Prowse & John Rea & Gregory Udell, 1993. "The economics of the private placement market," Staff Studies 166, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  3. Besanko, David & Thakor, Anjan V, 1987. "Collateral and Rationing: Sorting Equilibria in Monopolistic and Competitive Credit Markets," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(3), pages 671-89, October. [Downloadable!] (restricted)
  4. James, Christopher, 1987. "Some evidence on the uniqueness of bank loans," Journal of Financial Economics, Elsevier, vol. 19(2), pages 217-235, December. [Downloadable!] (restricted)
  5. Boyd, John H. & Prescott, Edward C., 1986. "Financial intermediary-coalitions," Journal of Economic Theory, Elsevier, vol. 38(2), pages 211-232, April. [Downloadable!] (restricted)
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  6. Booth, James R., 1992. "Contract costs, bank loans, and the cross-monitoring hypothesis," Journal of Financial Economics, Elsevier, vol. 31(1), pages 25-41. [Downloadable!] (restricted)
  7. Berger, Allen N & Udell, Gregory F, 1992. "Some Evidence on the Empirical Significance of Credit Rationing," Journal of Political Economy, University of Chicago Press, vol. 100(5), pages 1047-77, October. [Downloadable!] (restricted)
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  8. Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-76, June. [Downloadable!] (restricted)
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  9. Avery, Robert B. & Berger, Allen N., 1991. "Loan commitments and bank risk exposure," Journal of Banking & Finance, Elsevier, vol. 15(1), pages 173-192, February. [Downloadable!] (restricted)
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  10. Boot, Arnoud W A & Thakor, Anjan V & Udell, Gregory F, 1991. "Secured Lending and Default Risk: Equilibrium Analysis, Policy Implications and Empirical Results," Economic Journal, Royal Economic Society, vol. 101(406), pages 458-72, May. [Downloadable!] (restricted)
  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. 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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  13. Simon H. Kwan, 1994. "The certification value of bank loans," Proceedings, Federal Reserve Bank of Chicago, issue May, pages 547-562.
  14. Diamond, Douglas W, 1989. "Reputation Acquisition in Debt Markets," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 828-62, August. [Downloadable!] (restricted)
  15. Allen, Linda & Saunders, Anthony & Udell, Gregory F., 1991. "The pricing of retail deposits: Concentration and information," Journal of Financial Intermediation, Elsevier, vol. 1(4), pages 335-361, December. [Downloadable!] (restricted)
  16. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Blackwell Publishing, vol. 51(3), pages 393-414, July. [Downloadable!] (restricted)
  17. 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)
  18. James, Christopher & Wier, Peggy, 1990. "Borrowing relationships, intermediation, and the cost of issuing public securities," Journal of Financial Economics, Elsevier, vol. 28(1-2), pages 149-171. [Downloadable!] (restricted)
  19. Hoshi, Takeo & Kashyap, Anil & Scharfstein, David, 1990. "The role of banks in reducing the costs of financial distress in Japan," Journal of Financial Economics, Elsevier, vol. 27(1), pages 67-88, September. [Downloadable!] (restricted)
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  20. Greenbaum, Stuart I. & Kanatas, George & Venezia, Itzhak, 1989. "Equilibrium loan pricing under the bank-client relationship," Journal of Banking & Finance, Elsevier, vol. 13(2), pages 221-235, May. [Downloadable!] (restricted)
  21. Boot, Arnoud W A & Thakor, Anjan V, 1994. "Moral Hazard and Secured Lending in an Infinitely Repeated Credit Market Game," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 35(4), pages 899-920, November. [Downloadable!] (restricted)
  22. Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, vol. 47(4), pages 1367-400, September. [Downloadable!] (restricted)
  23. Takeo Hoshi & Anil Kashyap & David Scharfstein, 1990. "Bank Monitoring and Investment: Evidence from the Changing Structure of Japanese Corporate Banking Relationships," NBER Chapters, in: Asymmetric Information, Corporate Finance, and Investment, pages 105-126 National Bureau of Economic Research, Inc. [Downloadable!]
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  24. Thakor, Anjan V., 2000. "Relationship Banking," Journal of Financial Intermediation, Elsevier, vol. 9(1), pages 3-5, January. [Downloadable!] (restricted)
  25. Ramakrishnan, Ram T S & Thakor, Anjan V, 1984. "Information Reliability and a Theory of Financial Intermediation," Review of Economic Studies, Blackwell Publishing, vol. 51(3), pages 415-32, July. [Downloadable!] (restricted)
  26. Chan, Yuk-Shee & Thakor, Anjan V, 1987. " Collateral and Competitive Equilibria with Moral Hazard and Private Information," Journal of Finance, American Finance Association, vol. 42(2), pages 345-63, June. [Downloadable!] (restricted)
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  27. Orgler, Yair E, 1970. "A Credit Scoring Model for Commercial Loans," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 2(4), pages 435-45, November. [Downloadable!] (restricted)
  28. Takeo Hoshi & Anil Kashyap & David Scharfstein, 1989. "Bank monitoring and investment: evidence from the changing structure of Japanese corporate banking relations," Finance and Economics Discussion Series 86, Board of Governors of the Federal Reserve System (U.S.).
  29. Besanko, David & Thakor, Anjan V., 1987. "Competitive equilibrium in the credit market under asymmetric information," Journal of Economic Theory, Elsevier, vol. 42(1), pages 167-182, June. [Downloadable!] (restricted)
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  30. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-55, September. [Downloadable!] (restricted)
  31. 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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  32. 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)
Full references

Cited by:
(explanations, 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. Anil K. Kashyap & Raghuram Rajan & Jeremy C. Stein, 1999. "Banks as Liquidity Providers: An Explanation for the Co-Existence of Lending and Deposit-Taking," NBER Working Papers 6962, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. Anjan V. Thakor, 2004. "Capital Requirements, Monetary Policy, and Aggregate Bank," Finance 0411027, EconWPA. [Downloadable!]
  3. Takeo Hoshi & Anil Kashyap, 1999. "The Japanese Banking Crisis: Where Did It Come From and How Will It End?," NBER Working Papers 7250, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  4. James R. Barth & Glenn Yago & Betsy Zeidman, 2006. "Stumbling blocks to entrepreneurship in low-and-moderate income communities," Proceedings – Community Affairs Dept. Conferences, Federal Reserve Bank of Kansas City, issue Jul, pages 91-155. [Downloadable!]
  5. Joe Peek & Eric S. Rosengren, 1995. "Small business credit availability: how important is size of lender?," Working Papers 95-5, Federal Reserve Bank of Boston. [Downloadable!]
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