Petersen, Mitchell A.; Rajan, Raghuram G.
Working Paper
Does distance still matter? The information revolution
in small business lending
CSIO Working Paper, No. 0009
Provided in Cooperation with:
Department of Economics - Center for the Study of Industrial Organization (CSIO),
Northwestern University
Suggested Citation: Petersen, Mitchell A.; Rajan, Raghuram G. (2000) : Does distance still
matter? The information revolution in small business lending, CSIO Working Paper, No. 0009,
Northwestern University, Center for the Study of Industrial Organization (CSIO), Evanston, IL
This Version is available at:
http://hdl.handle.net/10419/38686
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THE CENTER FOR THE STUDY
OF INDUSTRIAL ORGANIZATION
AT NORTHWESTERN UNIVERSITY
Working Paper #0009
Does Distance Still Matter? The Information
Revolution in Small Business Lending
*
By
Mitchell A. Petersen
Kellogg Graduate School of Business
Northwestern University
and
Raghuram G. Rajan
Graduate School of Business
University of Chicago
March, 2000
*
Petersen thanks the Banking Research Center at Northwestern University’s Kellogg School while Rajan thanks the
Center for Research in Security Prices and the Center for the Study of the State and the Economy at the University
of Chicago, as well as the National Science Foundation for support.
Abstract
The distance between small firms and their lenders in the United States is increasing. Not only are
firms choosing more distant lenders, they are also communicating with them in more impersonal
ways. After documenting these systematic changes, we demonstrate that they are not a simple result
of changes in the location of small firms, consolidation in the banking industry, or of biases in the
sample. Instead, they seem correlated with improvements in bank productivity. We conjecture that
greater, and more timely, availability of borrower credit records, as well as the greater ease of
processing these may explain the greater amount of lending at a distance. Consistent with such an
explanation, unlike in the past, distant firms no longer have to be observably the highest quality
credits, suggesting that a wider cross-section of firms can now obtain funding from a particular
lender. If, as implied, the size of credit markets faced by even small firms has gone up as a result of
improvements in information technology, our results indicate that some consolidation of banking
services may not raise substantial anti-trust concerns.
1
Small business lending has historically been very costly, because of the paucity of
information about small firms and the high costs in terms of the personnel required to build the
relationships required to get even that information. There has, however, been an interesting trend in
small business lending; small businesses have been growing steadily more distant from their lenders.
This demonstrates itself in two ways.
First, borrowers are becoming physically more distant from lenders. The distance between
small firms and their lenders has grown from an average of 51 miles for lending relationships that
began in the seventies to 161 miles for relationships that began in the nineties. The same pattern can
be seen in the medians and seventy-fifth percentiles and across different kinds of lenders (see Table
I). While banks are indeed closer to their clients – reflecting the greater transactions and information
intensive nature of bank lending – even banks have been moving away; from an average of 16 miles
for lending relationships that began in the seventies to 68 miles for relationships that began in the
nineties.
A second trend is that the method of transacting business has moved increasingly from
personal contact to using the phone or the mail. This trend is partly a result of the first one, but even
correcting for physical distance, there seems to be a change in the manner of doing business.
What accounts for this trend? We show that changes in the location of small businesses,
consolidation in the banking industry, and sample selection biases, are unlikely explanations. One
possible explanation of the result is that a variety of infomediaries such as credit bureaus now exist.
They collect information on payment history and defaults that hitherto used to be available to a
lender only after a long relationship. Advances in storage technology and computing allow these
data to be easily retrieved and processed, and also communicated quickly. As a result, even distant
2
lenders have timely information that hitherto used to be soft and unavailable at arm’s length. This
may enables them to react quickly to unanticipated contingencies, minimizing the loss from delay,
and reducing the necessity to incur monitoring costs. Consistent with this conjecture, we show that
the increase in distance is strongly positively correlated with measures of bank productivity,
suggesting that reductions in the cost of gathering and analyzing information may indeed explain the
results.
If greater, and timely, availability of information about credit history is indeed part of the
explanation for why loans can now be made at a distance, we should find that distance is no longer
such a strong predictor of credit quality as in the past. Intuitively, in the past only unimpeachable
borrowers would have obtained credit at a distance because the costs of detecting potential borrower
distress and resolving it would have been prohibitively high for a distant lender. But if these costs
have fallen, then riskier credits should now be obtaining finance at a distance.
We do find that even though lender distance is a good indicator of creditworthiness, it is less
important a measure than in the past. This suggests weaker credits are obtaining loans at a distance.
Consistent with our argument that lenders are better able to monitor and control these credits, we do
not find a commensurate increase in lender loan losses over our sample period. We therefore
conclude the evidence is consistent with greater information availability being responsible for the
increasing distance between lender and borrower.
Our evidence has a number of implications. There has been a debate about whether
institutional lending, especially bank lending, is in a state of permanent decline because of the greater
availability of information to arm’s length financial markets today (see Boyd and Gertler (1994) and
Gorton and Rosen (1995) for two views). Our evidence suggests that institutional lending also
