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Journal Article•DOI•

Relationship Banking: What Do We Know?

Arnoud W. A. Boot1•
University of Amsterdam1
01 Jan 2000-Journal of Financial Intermediation (Academic Press)-Vol. 9, Iss: 1, pp 7-25
TL;DR: In this paper, the authors briefly review the contemporary literature on relationship banking and discuss how relationship banking fits into the core economic services provided by banks and point at its costs and benefits.
About: This article is published in Journal of Financial Intermediation.The article was published on 2000-01-01. It has received 2302 citations till now. The article focuses on the topics: Retail banking & Transaction banking.
Citations
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Journal Article•DOI•
Small Business Credit Availability and Relationship Lending: The Importance of Bank Organisational Structure

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Allen N. Berger1, Gregory F. Udell1•
Federal Reserve System1
01 Sep 2001-The Economic Journal
TL;DR: In this paper, the inner workings of relationship lending, the implications for bank organisational structure, and the effects of shocks to the economic environment on the availability of relationship credit to small businesses are modeled.
Abstract: This paper models the inner workings of relationship lending, the implications for bank organisational structure, and the effects of shocks to the economic environment on the availability of relationship credit to small businesses. Relationship lending depends on the accumulation over time by the loan officer of 'soft' information. Because the loan officer is the repository of this soft information, agency problems are created throughout the organisation that may best be resolved by structuring the bank as a small, closely-held organisation with few managerial layers. The shocks analysed include technological innovations, regulatory regime shifts, banking industry consolidation, and monetary policy shocks. The issue of credit availability to small firms has garnered world-wide concern recently. Models of equilibrium credit rationing that point to moral hazard and adverse selection problems (eg, Stiglitz and Weiss, 1981) suggest that small firms may be particularly vulnerable because they are often so informationally opaque. That is, the informational wedge between insiders and outsiders tends to be more acute for small companies, which makes the provision of external finance particularly challenging. Small firms with opportunities to invest in positive net present value projects may be blocked from doing so because potential providers of external finance cannot readily verify that the firm has access to a quality project (adverse selection problem) or ensure that the funds will not be diverted to fund an alternative project (moral hazard problem).

1,745 citations

Cites background from "Relationship Banking: What Do We Kn..."

  • ...Relationship 1 See Berger and Udell (1998) and Boot (2000) for reviews of this literature and the empirical evidence on relationship lending....

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Journal Article•DOI•
How Does Capital Affect Bank Performance During Financial Crises

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Allen N. Berger1, Allen N. Berger2, Christa H. S. Bouwman1, Christa H. S. Bouwman3•
University of Pennsylvania1, University of South Carolina2, Texas A&M University3
16 Dec 2012-Social Science Research Network
TL;DR: The authors empirically examined how capital affects a bank's performance (survival and market share), and how this effect varies across banking crises, market crises, and normal times that occurred in the U.S over the past quarter century.
Abstract: This paper empirically examines how capital affects a bank’s performance (survival and market share), and how this effect varies across banking crises, market crises, and normal times that occurred in the U.S. over the past quarter century. We have two main results. First, capital helps small banks to increase their probability of survival and market share at all times (during banking crises, market crises, and normal times). Second, capital enhances the performance of medium and large banks primarily during banking crises. Additional tests explore channels through which capital generates the documented effects. Numerous robustness checks and additional tests are performed.

1,080 citations

Cites background or methods from "Relationship Banking: What Do We Kn..."

  • ..., Boot and Thakor, 2000). This may be because relationship borrowers, who benefit from long-term interactions with the bank, would prefer a bank with higher capital and higher odds of survival, all else equal. This might not only improve the bank’s lending margins, but also enhance loan volume, thereby increasing market share. Moreover, it would provide the balance-sheet stability that is valuable for survival. If we had loan-level data, we could construct a relationship loan measure based on duration and scope, two dimensions deemed important in the relationship lending literature (e.g., Boot, 2000; Ongena and Smith, 2000; Degryse and Ongena, 2007). If we had firm-level data, we could calculate the bank’s share of the firm’s total debt (e.g., Presbitero and Zazzaro, 2011). Because we only have Call Report data, we use a more crude measure and view total loans excluding loans to depository institutions, foreign governments, and states as relationship loans. Buyers of off-balance-sheet guarantees are more likely to buy claims from less risky, more reputable banks. Boot, Greenbaum, and Thakor (1993) predict this, and higher financial capital stochastically elevates reputational capital in their model....

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  • ...…construct a relationship loan measure based on duration and scope, two dimensions deemed important in the relationship lending literature (e.g., Boot, 2000; Ongena and Smith, 2000; Degryse and 25 The individual crisis IV results for small banks show that the instrument is positively and…...

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Journal Article•DOI•
Distance, Lending Relationships and Competition

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Hans Degryse1, Steven Ongena1•
Tilburg University1
01 Feb 2005-Journal of Finance
TL;DR: In this paper, the authors study the effect on loan conditions of geographical distance between firms, the lending bank, and all other banks in the vicinity, and report the first comprehensive evidence on the occurrence of spatial price discrimination in bank lending.
Abstract: We study the effect on loan conditions of geographical distance between firms, the lending bank, and all other banks in the vicinity. For our study, we employ detailed contract information from more than 15,000 bank loans to small firms comprising the entire loan portfolio of a large Belgian bank. We report the first comprehensive evidence on the occurrence of spatial price discrimination in bank lending. Loan rates decrease with the distance between the firm and the lending bank and increase with the distance between the firm and competing banks. Transportation costs cause the spatial price discrimination we observe.

959 citations

Journal Article•DOI•
How does capital affect bank performance during financial crises

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Allen N. Berger1, Allen N. Berger2, Allen N. Berger3, Christa H. S. Bouwman4, Christa H. S. Bouwman2 •
University of South Carolina1, University of Pennsylvania2, Tilburg University3, Case Western Reserve University4
01 Jul 2013-Journal of Financial Economics
TL;DR: The authors empirically examined how capital affects a bank's performance and how this effect varies across banking crises, market crises, and normal times that occurred in the US over the past quarter century.

842 citations

Journal Article•DOI•
Lending Relationships and Loan Contract Terms

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Sreedhar T. Bharath1, Sandeep Dahiya2, Anthony Saunders3, Anand Srinivasan4•
University of Michigan1, Georgetown University2, New York University3, National University of Singapore4
28 Jul 2008-Social Science Research Network
TL;DR: This article found that repeated borrowing from the same lender affects loan contract terms and that such borrowing translates into a 10 to 17 bps lowering of loan spreads, and that the relationship borrowers obtain larger loans compared to non-relationship borrowers.
Abstract: Does repeated borrowing from the same lender affect loan contract terms? We find that such borrowing translates into a 10 to 17 bps lowering of loan spreads. These results hold using multiple approaches (Propensity Score Matching, Instrumental Variables, and Treatment Effects Model) that control for the endogeneity of relationships. We find that relationships are especially valuable when borrower transparency is low and the moral hazard among lending syndicate members is high. We also provide a demarcation line between relationship and transactional lending. We find that spreads charged for relationship loans and non-relationship loans become indistinguishable if the borrower is in the top 30% when ranked by asset size. Similar dissipation of relationship benefits occurs if the borrower has public rated debt or is part of the S&P 500 index. We find that past relationships reduce collateral requirements. Relationships are also associated with shorter debt maturity especially for the lowest quality borrowers. Our results are robust to an estimation methodology which allows loan spread, collateral requirements, and loan maturity to be determined jointly using an instrumental variables approach. We also find relationship borrowers obtain larger loans (scaled by the borrower's asset size) compared to non-relationship borrowers. Our results imply that, even for firms that have multiple sources of outside financing, borrowing from a prior lender obtains better loan terms.

832 citations

Cites background from "Relationship Banking: What Do We Kn..."

  • ...These loan terms include loan price variables: all-in-spread-drawn (AISD), all-in-spread-undrawn (AISU), upfront fee, and annual fee.(14)...

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References
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Posted Content•DOI•
Credit Rationing in Markets with Imperfect Information.

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Joseph E. Stiglitz, Andrew Weiss
01 Jan 1981-The American Economic Review
TL;DR: In this paper, a model is developed to provide the first theoretical justification for true credit rationing in a loan market, where the amount of the loan and amount of collateral demanded affect the behavior and distribution of borrowers, and interest rates serve as screening devices for evaluating risk.
Abstract: According to basic economics, if demand exceeds supply, prices will rise, thus decreasing demand or increasing supply until demand and supply are in equilibrium; thus if prices do their job, rationing will not exist. However, credit rationing does exist. This paper demonstrates that even in equilibrium, credit rationing will exist in a loan market. Credit rationing is defined as occurring either (a) among loan applicants who appear identical, and some do and do not receive loans, even though the rejected applicants would pay higher interest rates; or (b) there are groups who, with a given credit supply, cannot obtain loans at any rate, even though with larger credit supply they would. A model is developed to provide the first theoretical justification for true credit rationing. The amount of the loan and the amount of collateral demanded affect the behavior and distribution of borrowers. Consequently, faced with increased credit demand, it may not be profitable to raise interest rates or collateral; instead banks deny loans to borrowers who are observationally indistinguishable from those receiving loans. It is not argued that credit rationing always occurs, but that it occurs under plausible assumptions about lender and borrower behavior. In the model, interest rates serve as screening devices for evaluating risk. Interest rates change the behavior (serve as incentive mechanism) for the borrower, increasing the relative attractiveness of riskier projects; banks ration credit, rather than increase rates when there is excess demand. Banks are shown not to increase collateral as a means of allocating credit; although collateral may have incentivizing effects, it may have adverse selection effects. Equity, nonlinear payment schedules, and contingency contracts may be introduced and yet there still may be rationing. The law of supply and demand is thus a result generated by specific assumptions and is model specific; credit rationing does exist. (TNM)

13,126 citations

"Relationship Banking: What Do We Kn..." refers background in this paper

  • ...collateral requirements. An extensive theoretical literature shows that collateral can mitigate moral hazard and adverse selection problems in loan contracting (see Chan and Thakor (1987) and Stiglitz and Weiss (1981) ).13 However, collateral is likely to be effective only if its value can be monitored (see Rajan and Winton (1995))....

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  • ...…theoretical literature shows that collateral can mitigate moral hazard and adverse selection problems in loan contracting (see Chan and Thakor (1987) and Stiglitz and Weiss (1981)).13 However, collateral is likely to be effective only if its value can be monitored (see Rajan and Winton (1995))....

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Journal Article•DOI•
Bank Runs, Deposit Insurance, and Liquidity

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Douglas W. Diamond, Philip H. Dybvig
01 Jun 1983-Journal of Political Economy
TL;DR: The authors showed that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits, and showed that there are circumstances when government provision of deposit insurance can produce superior contracts.
Abstract: This paper shows that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits. Investors face privately observed risks which lead to a demand for liquidity. Traditional demand deposit contracts which provide liquidity have multiple equilibria, one of which is a bank run. Bank runs in the model cause real economic damage, rather than simply reflecting other problems. Contracts which can prevent runs are studied, and the analysis shows that there are circumstances when government provision of deposit insurance can produce superior contracts.

9,099 citations

"Relationship Banking: What Do We Kn..." refers background in this paper

  • ...That is, banks may smooth the stochastic individual demand for liquidity; see for example Diamond and Dybvig (1983) ....

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  • ...That is, banks may smooth the stochastic individual demand for liquidity; see for example Diamond and Dybvig (1983)....

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Journal Article•DOI•
Financial Intermediation and Delegated Monitoring

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Douglas W. Diamond1•
University of Chicago1
01 Jul 1984-The Review of Economic Studies
TL;DR: In this paper, the authors developed a theory of financial intermediation based on minimizing the cost of monitoring information which is useful for resolving incentive problems between borrowers and lenders, and presented a characterization of the costs of providing incentives for delegated monitoring by a financial intermediary.
Abstract: This paper develops a theory of financial intermediation based on minimizing the cost of monitoring information which is useful for resolving incentive problems between borrowers and lenders. It presents a characterization of the costs of providing incentives for delegated monitoring by a financial intermediary. Diversification within an intermediary serves to reduce these costs, even in a risk neutral economy. The paper presents some more general analysis of the effect of diversification on resolving incentive problems. In the environment assumed in the model, debt contracts with costly bankruptcy are shown to be optimal. The analysis has implications for the portfolio structure and capital structure of intermediaries.

7,982 citations

"Relationship Banking: What Do We Kn..." refers background in this paper

  • ...We know that information asymmetries are central to the literature on financial intermediation as developed by Diamond (1984) and others (see Bhattacharya and Thakor (1993) for a review). In fact, the raison d’̂etre of banks may well be their role in mitigating informational asymmetries. Relationship banking is most directly aimed at resolving problems of asymmetric information. What is interesting is that this way of looking at relationship banking takes us beyond the traditional focus on commercial bank lending; relationships play a critical role in investment banking as well and in the activities of nonbank financial intermediaries and private equity and debt markets. The second set consists of questions about the source of the benefitsof relationship banking. Questions addressed here include the following: What makes a relationship lender special? And what are the value-enhancing contractual features of relationship lending? One main insight with respect to the first question is that the dominance of relationship lending may resolve Grossmann and Hart (1980)-type free-rider problems and facilitate information reusability over time....

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  • ...12Diamond (1993), Bergl ̈ of and Von Thadden (1993), and Gorton and Kahn (1993) address the priority structure....

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  • ...We know that information asymmetries are central to the literature on financial intermediation as developed by Diamond (1984) and others (see Bhattacharya and Thakor (1993) for a review)....

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  • ...…of the important ongoing discussion in economic theory about rules versus discretion, where discretion allows decision making based on more subtle—potentially noncontractable—information.9 A bank–borrower relationship is in many ways 7 Diamond (1984) introduces intermediaries as delegated monitors....

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  • ...In the context of lending, this information is obtained when banks provide screening (Allen, 1990; Ramakrishnan and Thakor, 1984) and/or monitoring services (Diamond, 1984; Winton, 1995)....

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Journal Article•DOI•
The Benefits of Lending Relationships: Evidence from Small Business Data

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Mitchell A. Petersen, Raghuram G. Rajan
01 Mar 1994-Journal of Finance
TL;DR: In this article, the authors empirically examined how ties between a firm and its creditors affect the availability and cost of funds to the firm and found that the primary benefit of building close ties with an institutional creditor is that the availability of financing increases.
Abstract: This paper empirically examines how ties between a firm and its creditors affect the availability and cost of funds to the firm. We analyze data collected in a survey of small firms by the Small Business Administration. The primary benefit of building close ties with an institutional creditor is that the availability of financing increases. We find smaller effects on the price of credit. Attempts to widen the circle of relationships by borrowing from multiple lenders increases the price and reduces the availability of credit. In sum, relationships are valuable and appear to operate more through quantities rather than prices.

5,026 citations

"Relationship Banking: What Do We Kn..." refers background in this paper

  • ...First, the duration of the bank–borrower relationship positively affects the availability of credit (Petersen and Rajan, 1994; Berger and Udell, 1995)....

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  • ...In this way, banks could charge (ex post) high loan interest rates (see Sharpe (1990) and Rajan (1992))....

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  • ...(see for example Petersen and Rajan (1994) and Berger and Udell (1995))....

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  • ...Third, there is evidence of intertemporal smoothing of contract terms that could also contribute to the increased availability of funds to “young” firms (Petersen and Rajan, 1994, 1995)....

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  • ...Alternatively, the presence of multiple lenders causes “too much” competition ex post that can discourage lending to young firms (Petersen and Rajan, 1994)....

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Journal Article•DOI•
INSIDERS AND OUTSIDERS: The Choice between Informed and Arm's-length Debt

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Raghuram G. Rajan
01 Sep 1992-Journal of Finance
TL;DR: In this paper, the authors argue that while informed banks make flexible financial decisions which prevent a firm's projects from going awry, the cost of this credit is that banks have bargaining power over the firm's profits, once projects have begun.
Abstract: While the benefits of bank financing are relatively well understood, the costs are not. This paper argues that while informed banks make flexible financial decisions which prevent a firm's projects from going awry, the cost of this credit is that banks have bargaining power over the firm's profits, once projects have begun. The firm's portfolio choice of borrowing source and the choice of priority for its debt claims attempt to optimally circumscribe the powers of banks. ACCORDING TO RECEIVED THEORY, banks reduce the agency costs associated with lending to small and medium growth firms in various ways.' Yet in practice, many such firms diversify away from bank financing even if banks are willing to lend more.2 Why do these firms forsake informed and seemingly more efficient sources of debt finance to borrow from less informed arm's-length sources? While the benefits of bank financing are relatively well understood, the costs are not. This paper argues that while informed banks make flexible financial decision which prevent a firm's projects from going awry, the cost of this credit is that banks have bargaining power over the firm's profits, once projects have begun. The firm's choice of borrowing sources and the choice of priority for its debt claims attempt to optimally circumscribe the powers of banks.

3,864 citations

"Relationship Banking: What Do We Kn..." refers background in this paper

  • ...In this way, banks could charge (ex post) high loan interest rates (see Sharpe (1990) and Rajan (1992))....

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Related Papers (5)
The Benefits of Lending Relationships: Evidence from Small Business Data

[...]

01 Mar 1994-Journal of Finance
Mitchell A. Petersen, Raghuram G. Rajan
Relationship Lending and Lines of Credit in Small Firm Finance

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01 Jan 1995-The Journal of Business
Allen N. Berger, Gregory F. Udell
INSIDERS AND OUTSIDERS: The Choice between Informed and Arm's-length Debt

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01 Sep 1992-Journal of Finance
Raghuram G. Rajan
Asymmetric Information, Bank Lending, and Implicit Contracts: A Stylized Model of Customer Relationships

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01 Sep 1990-Journal of Finance
Steven A. Sharpe
Financial Intermediation and Delegated Monitoring

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01 Jul 1984-The Review of Economic Studies
Douglas W. Diamond