Lending Relationships and the Collateral Channel

Abstract

This paper shows that lending relationships insulate corporate investment from shocks to collateral values. We construct a novel database covering the banking relationships of UK firms, as well as those of their board members and executives. We find that the sensitivity of corporate investment to shocks to real estate collateral value is halved when the length of the bank-firm relationship increases from the 25th to the 75th percentile. This effect is substantially reduced for firms whose executives have a personal mortgage relationship with their firm's bank. Our findings provide support for theories where collateral and private information are substitutes in mitigating credit frictions over the cycle.

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“…Moreover, even if banks located in the same region lend to a given industry in a geographically similar way, variation across each banks' borrowers within an industry can also undermine this method of identification. For example, the nature of lending relationships, which we cannot observe, can have important effects on the transmission of monetary policy through the collateral channel, as described in Anderson et al (2018). Finally, the strategy will not capture variation in loan demand that stems from firms that shift borrowing preferences based on banks' exposure to NIRP.…”

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“…This problem is mitigated by a bank taking collateral which makes the given bank's loan senior to other creditors' claims, giving rise to complementarity between collateral and monitoring. We investigate this issue in the context of the UK in a separate paper (Anderson et al, 2018).…”

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“…Additionally, the banker can obtain information indirectly through his or her relationships with members of the network (Ferrary, 2003). These aspects can play an import role in the light of recent evidence indicating that personal relationships between the loan officers and firm executives affect the financial constraints of the firms (Anderson et al, 2018), and benefit firms across loan terms (Karolyi, 2018).…”