When arm's length is too far: Relationship banking over the credit cycle

Abstract

Using a novel way to identify relationship and transaction banks, we study how banks' lending techniques affect credit constraints of small and medium-sized enterprises across emerging Europe. We link the lending techniques that banks use in the direct vicinity of firms to these firms' credit constraints at two contrasting points of the credit cycle. We show that relationship lending alleviates credit constraints during a cyclical downturn but not during a boom period. The positive impact of relationship lending in a downturn is strongest for smaller and more opaque firms and in regions where the downturn is more severe. Additional evidence suggests that the reduction in credit constraints due to relationship lending helps to mitigate the adverse impact of an economic downturn on local firm growth and does not constitute evergreening of underperforming loans. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means without the prior permission in writing of the publisher nor be issued to the public or circulated in any form other than that in which it is published.Requests for permission to reproduce any article or part of the Working Paper should be sent to the editor at the above address. Ralph De Haas (European Bank for Reconstruction and Development and Tilburg University) Neeltje van Horen (De Nederlandsche Bank and CEPR)February 2015 AbstractUsing a novel way to identify relationship and transaction banks, we study how banks' lending techniques affect credit constraints of small and medium-sized enterprises across emerging Europe. We link the lending techniques that banks use in the direct vicinity of firms to these firms' credit constraints at two contrasting points of the credit cycle. We show that relationship lending alleviates credit constraints during a cyclical downturn but not during a boom period. The positive impact of relationship lending in a downturn is strongest for smaller and more opaque firms and in regions where the downturn is more severe. Additional evidence suggests that the reduction in credit constraints due to relationship lending helps to mitigate the adverse impact of an economic downturn on local firm growth and does not constitute evergreening of underperforming loans (JEL codes: F36; G21; L26; O12; 016).

Bank Competition, Foreign Bank Entry, and Risk-Taking Behavior: Cross Country Evidence

“…On the one side, the entry of foreign banks might concentrate their credit and other services on well-informed customers, depriving the domestic banks of this market position and leaving only opaque organizations (Sengupta 2007;Ukaegbu and Oino 2014). Beck et al (2018) argued that foreign banks' entry affects the availability of credit for small or opaque organizations. They suggest that larger firms may get benefits from the existence of a foreign bank(s), but small firms are not affected.…”

Bank lending technologies and credit availability in Europe: What can we learn from the crisis?

“…While transactional lending techniques and hard data are more appropriate for transparent firms and during tranquil periods, relationship lending technologies and soft information are employed with opaque borrowers suffering from more intense information asymmetries (Stein, 2002;Bartoli et al, 2013) and may become especially valuable towards the generality of borrowers when a systemic crisis magnifies information asymmetries (Beck et al, 2015;Ferri et al, 2001). 1 In fact, hard information is less reliable in predicting firm risk profile under uncertainty, whereas continuously updated soft information is better targeted to borrowers' characteristics (Rajan, 1992;Stein, 2002;Berger and Udell, 2006;Rajan et al, 2015).…”

The Impact of Social and Economic Factors in the Credit Risk Management of Sme

“…However, the topics are still interesting for the academic researcher due to information opacity related to SME financing. It is disputable that SME represent opaque information and due to this fact, it is difficult for the lenders to evaluate the credit risk of the borrowers (Beck, Degryse, De Haas, & Van Horen, 2015).…”