Competition and Relationship Lending: Friends or Foes?

Recent empirical findings by Elsas (2005) and Degryse and Ongena (2007) document a U-shaped effect of market concentration on relationship lending which cannot be easily accommodated by the investment and strategic theories of relationship lending. In this paper, we suggest that this non-monotonicity can be explained by looking at the organizational structure of local credit markets. We provide evidence that marginal increases in interbank competition are detrimental to relationship lending in markets where large and out-of-market banks are predominant. On the contrary, where relational-based lending technologies are al-ready widely in use in the market by a large group of small mutual banks, an increase in competition may drive banks to further cultivate their extensive ties with customers.interbank competition, market organizational structure, relationship lending

International Similarities of Bank Lending Practices and Varieties of Insolvency Laws: a Comparative Analysis of France and Germany

Economic theory conjectures complementarities between the ranking of creditors in formal insolvency proceedings and the use of collateral in bank loan contracts as well as the existence of relational compared to arms length lending. In this paper we seek evidence for these hypotheses taking France and Germany as examples which differ significantly concerning the ranking of in particular secured creditors. On closer scrutiny of empirical studies as well as statistical information we can neither confirm that a high priority for se-cured lenders explains an excessive use of collateral in bank loans nor that a priority for inside collateral promotes relational lending. Regarding relational lending we point to variables lying outside the insolvency law, like culture and history

A relational theory of relationship lending under contractual incompleteness

While the literature has focused on relationships as a technology for solving hidden information problems in credit markets, hidden action has been very little explored as an explanation for the existence of relational lending. In this paper, we propose a theory in which relationships are driven by the problem of contractual incompleteness in instances in which a borrower, by taking ex-ante actions, magnifies the hazards related to ex-post bargaining over returns. A relationship commits the borrower to take actions that minimize the ex-post conflict of interests resulting from contractual incompleteness. We show that a robust feature of an optimally designed lending relationship (i.e., the best Public Perfect Pure Strategy Equilibrium in a repeated lending game) is that a sufficiently patient entrepreneur, upon choosing his actions, ignores his privately observed contingencies. This commitment solves the credit rationing problem that arises in a one-shot (arm’s length) interaction, and reduces, when compared to arm’s length financing, the interest rate that a bank charges for a credit line. Although in a less acute fashion, we also show that the same features just described appear in an optimal lending relationship for the case in which the entrepreneur is impatient.

Reputation and Credit Market Formation: How Relational Incentives and Legal Contract Enforcement Interact

The evidence suggests that relational contracting and legal rules play an important role in credit markets but on the basis of the prevailing field data it is difficult to pin down their causal impact. Here we show experimentally that relational incentives are a powerful causal determinant for the existence and performance of credit markets. In fact, in the absence of legal enforcement and reputation formation opportunities the credit market breaks down almost completely while if reputation formation is possible a stable credit market emerges even in the absence of legal enforcement of debt repayment. Introducing legal enforcement of repayments causes a further significant increase in credit market trading but has only a surprisingly small impact on overall efficiency. The reason is that legal enforcement of debt repayments weakens relational incentives and exacerbates another moral hazard problem in credit markets – the choice of inefficient high-risk projects.credit markets, relationship lending, reputation formation, legal enforcement

Long-Lasting Bank Relationships and Growth of Firms

A puzzling but consistent result in the empirical literature on banking is that firms with close bank ties do not grow faster than bank-independent firms. In this paper, we reconsider the link between relationship lending and firms’ growth, distinguishing firms by size and “health”. The idea is that the beneficial effects of relationship lending on information asymmetries can be compensated by other negative capture, risk and externality effects which make relational banks reluctant to support long-term growth projects of client firms, and that the strength of these compensating effects varies with firm size and health status. We explore the influence of long-lasting bank relationships on employment and asset growth of a large sample of Italian firms. The main finding is that relationship lending hampers the efforts of small firms to increase their size, while it mitigates the negative growth of troubled, medium-large enterprises.relationship lending, capture effects, firms’ growth

Do Firm-Bank `Odd Couples' Exacerbate Credit Rationing?

We start considering an optimal matching of opaque (transparent) borrowing firrms with relational (transactional) lending main banks. Next we contemplate the possibility that firm-bank "odd couples" materialize where opaque (transparent) firrms end up matched with transactional (re- lational) main banks. We conjecture the "odd couples" emerge either since the bank's lending technology is not perfectly observable to the rm or because riskier firrms - even though opaque - strategically select transac- tional banks in the hope of being classified as lower risks. Our econometric results show the probability of rationing is larger when firrms and banks match in "odd couples".Relationship Banking, Credit Rationing and Asymmetric Information

Consumer credit in comparative perspective

We review the literature in sociology and related fields on the fast global growth of consumer credit and debt and the possible explanations for this expansion. We describe the ways people interact with the strongly segmented consumer credit system around the world—more specifically, the way they access credit and the way they are held accountable for their debt. We then report on research on two areas in which consumer credit is consequential: its effects on social relations and on physical and mental health. Throughout the article, we point out national variations and discuss explanations for these differences. We conclude with a brief discussion of the future tasks and challenges of comparative research on consumer credit.Accepted manuscrip

Relational Contracting Under the Threat of Expropriation – Experimental Evidence

We examine how relational contracting in credit and investment relationships is affected by the potential expropriation of funds. We implement credit relationships in which repayment is not third-party enforceable, i.e. borrowers can default on their loans. In our main treatment the borrower can expropriate the lender’s funds: a defaulting borrower can reinvest the loaned funds in future periods. In a control treatment borrowers cannot expropriate borrowed funds, i.e. if they default they cannot reinvest these funds in future periods. We find that potential expropriation decreases the overall volume of credit as lenders offer smaller loans in initial periods. Borrowers are more likely to default in earlier periods of the relationship when expropriation is possible, especially when they receive large loans. Together these results suggest that relational contracts may be particularly difficult to establish in markets where the expropriation of funds is feasible. This finding is relevant to credit markets in which lenders’ rights are weak, but also to sovereign lending, as well as to foreign direct investment in countries with weak investor protection.Relational contracts;Investor protection;Banking;Sovereign debt;Foreign direct investment.

Business Groups in Emerging Markets - Substitutes for Missing Institutions

Abstract: Business groups in emerging markets perform better than unaffiliated firms. We study how business groups can substitute some functions of missing institutions, for example, enforcing contracts. In a two period model, there is no contract enforcement in the first period. The firms within the business group are connected to each other by a vertical production structure, resulting in externalities due to double marginalization, and an internal capital market. Our model derives the sequencing of investments and the credit contract offered by the headquarters that solve the ex post moral hazard problem. Thus, the business group's organizational mode and the financial structure facilitate relational contracting