Abstract:Reliable information on small and medium sized enterprises (SMEs) is rare and costly for financial intermediaries. Therefore relationship banking is often considered as the appropriate lending technique. In this paper we offer a theoretical model to analyze relationship banking and the pricing behavior of banks in a Bertrand competition framework with monitoring costs.We show that the lack of reliable information leads to comparably high interest rates even if a long-term relationship between borrower and bank exists. The paper offers a theoretical explanation why SMEs often are faced with borrowing constraints. (91 words)

Abstract:Reliable information on small and medium sized enterprises (SMEs) is rare and costly for financial intermediaries. Therefore relationship banking is often considered as the appropriate lending technique. In this paper we offer a theoretical model to analyze relationship banking and the pricing behavior of banks in a Bertrand competition framework with monitoring costs.We show that the lack of reliable information leads to comparably high interest rates even if a long-term relationship between borrower and bank exists. The paper offers a theoretical explanation why SMEs often are faced with borrowing constraints. (91 words)

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