Cookie Cutter vs. Character: The Micro Structure of Small Business Lending by Large and Small Banks

Abstract

The informational opacity of small businesses makes them an interesting area for the study of banks' lending practices and procedures. We use data from a survey of small businesses to analyze the micro level differences in the loan approval processes of large and small banks. We provide evidence that large banks ($1 billion or more in assets) employ standard criteria obtained from financial statements in the loan decision process, whereas small banks rely to a greater extent on information about the character of the borrower. These cookie-cutter and character approaches are compatible with the incentives and environments facing large and small banks.

Why Do Firms Switch Banks? Evidence from China

“…It is argued that small banks are more eager to extend their business and have higher propensity to lend than large banks 3 . Large banks usually rely more on observable firm characteristics in making lending decision than small banks (Cole et al, 1999), which implies they are less willing to lend than small banks under the same conditions of information asymmetry. Furthermore, small banks are more efficient at lending to small firms than large banks (Sapienza, 2002) which supports the argument that medium and small firms are more likely to switch to small banks.…”

SMES and Bank Lending Relationships: The Impact of Mergers

“…Large banks concentrate on larger firms, and reduce the amount of lending to small businesses (see also Weston, 1998, andPeek andRosengren, 1996). This may be driven by the fact that: (1) servicing large versus small firms is entirely different (transactional lending versus relationship lending; also see Rajan (1994, 1995)); or (2) small banks have a better technology for servicing small firms (see also Cole et al, 2004, andUdell, 1989). This implies that if larger banks reduce the supply of credit to small borrowers, small borrowers may be more likely to lose their relationships.…”

Microfinance, EU Structural Funds and Capacity Building for Managing Authorities

“…In particular, local banks have always played a prominent role in financing the SMEs, as they -thanks to their operations in geographically circumscribed areas and effective distribution networks -were able to build solid long-term relationship with local enterprises based on reciprocal trust and following a relationship banking pattern (Cole et al, 2004;Berger and Udell, 2002;Prager and Wolken, 2008). Their operating model enjoys a number of consolidated advantages; specifically, the same geographical and cultural vicinity as the enterprises; good customer relationship management; the acquisition of information on the local environment and clientele, which becomes an information edge when assessing creditworthiness and credit lines; the search and use of soft information, namely quality and reserved data, a type of non-structured information which can only originate from long-term relationships with the borrowers; a light and efficient organisational structure, which facilitates their capacity to pick up information and take decisions in a timely effective fashion.…”