Lending Relationships and the Collateral Channel

This article shows that lending relationships insulate corporate investment from fluctuations in collateral values. The sensitivity of corporate investment to changes in real-estate collateral values is halved when the length of relationship between a bank and a firm, or its board of directors, doubles. Long relationships with board members dominate relationships with the firm in dampening the collateral channel. Moreover, lending relationships with directors in their personal capacity insulate corporate investment over and above corporate relationships. Our findings support theories where collateral and private information are substitutes in mitigating credit frictions over the cycle and show that lending relationships are more multi-faceted than previously thought

Lending relationships and the collateral channel

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