This paper attempts to verify the existence and impact of multiple banking practices on corporate borrowers of Bangladesh. In doing so we have analyzed multiple borrowing with respect to availability of credit and interest rate charged. As methodology of the study, we have conducted literature survey and empirical analysis. The results of the analysis show that there is widespread practice of multiple borrowing among the corporate borrowers in Bangladesh. Finally, the results of the statistical analysis reveal that such practice enables firms to borrow at comparatively lower interest expense, but to suffer from limited access to credit

Ahmed Sarwar Uddin

Uchida Shigeru

Uchida, Shigeru

Ahmed, Sarwar Uddin

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Multiple Banking Practices and its Impact on the Corporate Borrowers : A Case Study of Bangladesh

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KEIEI TO KEIZAI, Vo1.83 No.3, December 2003 245Multiple Banking Practices and its Impacton the Corporate Borrowers- A Case Study of Bangladesh* -K. S. Sarwar Uddin AHMED tShigeru UCHIDA ~AbstractThis paper attempts to verify the existence and impact of multiplebanking practices on corporate borrowers of Bangladesh. In doing so wehave analyzed multiple borrowing with respect to availability of creditand interest rate charged. As methodology of the study, we have con-ducted literature survey and empirical analysis. The results of the analy-sis show that there is widespread practice of multiple borrowing amongthe corporate borrowers in Bangladesh. Finally, the results of thestatistical analysis reveal that such practice enables firms to borrow atcomparatively lower interest expense, but to suffer from limited accessto credit.Keywords: multiple banking practice, corporate borrowers,debt-equity ratio, interest expense1. Introduction1.1 Multiple Banking and Corporate FinanceIn recent days multiple borrowing propensity of corporate firms in. Ban-t PhD Student, Graduate School of Science and Technology, Nagasaki University.:j: Professor, Faculty of Economics, Nagasaki University.246 KEIEI TO KEIZAIgladesh is in increasing trend. As a result of this, banks are giving advice tofirms as outsiders rather than insiders and have tended to keep away fromfirms facing financial constraints. Even banks may compel a firm for prema-ture liquidation to protect its own interest (Ahmed, 1997). However, thereare also opposite version of this $tatement. Two theses are competing: oneasserts that multiple borrowing results in a desirable sharing of risks; theother, that the parcellization of loans substantially weakens the discipline ex-ercised by the banks and make sorporate borrowers more fragile (Fogilia etaI., 1998).In this background the objective of this paper is to verify the impact ofmultiple banking practices on the financial condition of the corporate bor-rowers in Bangladesh.1.2 ObjectivesThe aim of this paper is to verify whether multiple banking relationshipsoin Bangladesh cause negative impact on the balance sheet of the borrowerfirms. And the more specific objectives are as follows:1. To see the extent of interest spread variation of banks having differentnature of lending relationship.2. To verify whether borrowing relationship with a single bank or multiplebanks enable firms to get loans easily and vice versa.3. To review whether firms borrowing from a single bank or multiple bankscan borrow at lower interest rates.1.3 Methodology and DataIn order to verify the effect of single or multiple banking relationships onthe fragility of financial standings of corporate borrowers, we have conduct-Multiple Banking Practices and its Impact on the Corporate Borrowers- A Case Study of Bangladesh* - 247ed literature survey to know the current state of multiple banking practicesthrough out the world vis-a-vis Bangladesh. Then conducted numerical andstatistical analysis by gathering data from various sources e. g ., BalanceSheet Analysis of Joint Stock Companies, Statistics Department, BangladeshBank 2001, Bangladesh Bank Bulletin, Economic Trends- Bangladesh Bankand Scheduled Bank Statistics.2. Multiple Banking RelationshipThere are different studies citing .the merits and demerits of multiple bor-rowing practices by firms. Empirical studies in different countries confirm asignificant positive statistical connection between the intensity of the creditrelationship, i. e. its relative exclusiveness and duration, and the availabilityof outside financing to the firm (Foglia et al. 1998). It has been shown thatsmall US businesses with close banking relationships enjoy greater access tocredit, but not at lower cost (Peterson and Rajan, 1994 & 1995). Findingsrelative to small Japanese firms are similar: those with tight credit relation~ships are more capital-intensive, indicating less cogent liquidity constraintson investment, but not higher profits, owing to their financial costs (Wein-stein and Yafeh, 1994). Cole (1998) also concluded that potential lendersare less likely to extend credit to firms with multiple sources of financialservices, in support of the theory that the private information, a financial in-stitute generates about a firm, is less valuable when the firm deals with mul-tiple sources of financial services.While D' Auria, et al. (1998), found that for a given degree of concentra-tion in overall lending relationships, a more intensive relationship with a sin-gle bank results in the latter's charging a lower rate. For the firm, a248 KEIEI TO KEIZAIprivileged relationship thus appears preferable, at least until the share of itstotal borrowing gets so large as to confer a virtual lending monopoly for thebank (on the order of at least 80%). A further advantage of a close relation-ship with a bank, it has been argued, is less risk of sharp increases in interestrates during periods of tight money (Conigliani et aI., 1997).However, the advantages of multiple banking relationship have also beenstressed in some studies. From firms' standpoint, analysts have pointed outthe benefits of business relationships with a large number of banks, makingit easier to handle a request for repayment by anyone lender. In some casesfirms have succeeded to lower the average cost of their loan observedempir-ically by setting the banks in direct competition. Moreover, by exploitingcompetition between banks, firms may also obtain credit without having todivulge detailed information on their current accounts and future projects(Foglia et aI. 1998).In the backdrop of the literature review we can conclude that, there areboth merits and demerits in multiple banking relationship practices. Some ofwhich might be true and some might be irrelevant for the banking system ofBangladesh, which is difficult to answer without any deep insight into theproblem under discussion. Thus by taking this literature review as a back-ground, let us now examine the case of Bangladeshi corporate firms in orderto see whether or not multiple banking relationship is causing negative im-pact on the overall financial condition of the firms concerned.3. FindingsIn order to investigate the state of multiple banking practices in Ban-gladesh, a total of 155 joint stock companies listed in the Dhaka Stock Ex-Multiple Banking Practices and its Impact on the Corporate Borrowers- A Case Study of Bangladesh* - 249change are included in the analysis. Among which 73 were found to be main-taining borrowing relationship with a single bank and the rest 82 were hav-ing borrowing relationship with multiple banks (two or more banks). And- 100:c~(,) 80~s:::lU.0 60'0CD 400)!!'!s:::20~CDD. 01992 1993 1994 1995 1996 1997 1998 1999 2000YearIfill Single Lender Banks IlII OtherB~Figure 1. Share of bank credit: single lending bank vs. other banks-oQ)OlJ9c:~Q)a..42o1990- 1991- 1992- 1993- 1994- 1995- 1996- 1997- 1998- 1999- 2000-91 92 93 94 95 96 97 98 99 00 01Year[Iii-D~~~bl~-Sp~ead EB Actual Spread IFigure2. Actual and desirable interest spread250 KEIEI TO KEIZAI0.5 r--~------------------------'\~ 0.4'CtV~ 0.3II)I 0.2.!.5_ 0.1CDzo1992 1993 1994 1995 1996 1997 1998 1999 2000YearIII Single Lending Banks BOther Banks IFigure3. Comparative interest spread: single lending bank vs. other banks3.1 Majority Share of the Banks Lending as Single LenderAs shown in Figure1, in Bangladesh, among the banks-Sonali, Agrani,Janata, NBL and IFIC Bank are identified as the banks, which are mainlylending to the sample firms as their sole or single bank2). These banks arelending approximately 55-65 percent of the total advances of all banks. Thusbanks which are serving more as the single lender to firms are also providingmost of the loans in Bangladesh.3.2 Interest Rate SpreadIn the banking sector of Bangladesh, spread between the deposit and lend-ing interest rate is very high. As shown in Figure 2 the actual spread is ashigh as 7 percent, where the desirable spread is around 2 percent.However, if we compare the status of the firms under study, we can findthat the banks having single lending relationship with these firms have alower net interest spread as compared to those, which do not have such kindof relationship (see Figure 3). Thus it is interesting to verify from the follow-ing analysis that, whether firms borrowing from these single lender banksMultiple Banking Practices and its Impact on the Corporate Borrowers- A Case Study of Bangladesh* -can borrow at lower interest rates too.2513.3 Empirical Analysis3.3.1 Ratios ComparedFinally we have used t-tests of the differences between two means to findthe significance of difference on two financial ratios, viz., debt-equity ratioand ratio of interest expense to loans calculated for all the sample companiesby following the steps outlined below:a) First, we have divided the companies into two categories; one hav-ing the borrowing relationship with only a single bank and anotherhaving the same relationship with two or more banks.b) Next, applied t-tests to see whether there is any significant differ-ence in debt-equity ratio and ratio of interest expense to loans betweenthe companies having a single lending bank vis-a-vis companieshaving relationship with multiple banks.The reasons for selecting these two ratios as possible parameters to viewthe impact of single or multiple banking relationships are discussed below:(1) Debt-equity ratio (DER) : It is the ratio of fixed liabilities to sharehol-der's equity and calculated as follows:TFLDER= TSHEWhere TFL, TSHE representing total fixed liabilities, total share holders'equity respectively, and fixed liabilities include loan from banks. A higherdebt-equity ratio implies the dominance of bank loans as a source of financ-ing. This ratio is also used as a proxy for estimating the strength of bank-firm relationship. A higher debt-equity ratio implies reliance of a firm onbank financing. If the firms are borrowing from a single bank and also have252 KEIEI TO KEIZAIa higher debt-equity ratio, then it can be concluded that, this close bankingrelationship resulting from dealings with less banks, makes it easier for afirm to get bank loans.(2) Ratio of interest expense to loans (IELO): This ratio represents thetotal interest expense (TIE) to totaUoans outstanding (TLO) and is calcu-lated as follows:TIEIELO= TLOIt is a direct indication of the effectiveness of close relationship with singleor multiple banks. Firms possessing close banking relationship are assumedto be able to borrow at lower rates. As we have also discussed earlier that,for a given degree of concentration in overall lending relationships, a moreintensive relationship with a single bank results in charging a lower rate. Afurther advantage of a close relationship with a bank, it has been argued, isless risk of sharp increases in interest rates during periods of tight money.Whether or not this statement also applies in case of Bangladesh can beproved from this ratio.3.3.2 Test ResultsAccordingly, DER and IELO ratios calculated for the respective group ofcompanies having single or multiple lending banks are compared by t-teststatistics. The equation used for estimating the difference between twomeans is the following:t= (X;-Xz) - (Pl-P2) [lJ2 2~+~n j n2Multiple Banking Practices and its Impact on the Corporate Borrowers- A Case Study of Bangladesh* - 253. where, Xl is the mean of the sample taken. from population 1, III is themean of population 1, a~ is the variance of population 1, n l is size of the sam-ple taken from population 1, X 2 is the mean of the sample taken from popula-tion 2, ./12 is the mean of population 2, a~ is the variance of population 2, n2 isthe size of the sample taken from population 2:)The results of the t-tests are summarized through Table 1 and 2. Table1 shows the results of the difference of means of debt-equity ratio betweenTable 1 Debt-equity ratioSingle Bank Multiple Banks61 610.40 -0.141.48 1.210.12 0.16Mediant-test of paired samples:Difference in sample means 0.54t-Test Statistic 2.63P-Value 0.00Decision: Reject the null hypothesisSample Size (valid N)MeanS.D.Table 2 Ratio of interest expense to loans outstandingSingle Bank Multiple Banks61 610.57 0.331.21 0.760.18 0.14Mediant-test of paired samples:Difference in sample means 0 . 24t-Test Statistic 1. 31P-Value 0.19Decision: Do not reject the null hypothesisS.D.Sample Size (valid N)Mean254 KEIEI TO KEIZAIcompanies having single bank vis-a-vis multiple banks. From the table wecan see that the sample mean of the companies having single bank is higherthan that of the companies having multiple banks:) The states of t-statisticand p-value indicates that the difference between these two categories ofcompanies in debt-equity ratio is statistically significant (p=0.00) , 5% level,and leads us to reject the null hypothesis that there is no difference between them.On the contrary, the results of the difference of means of ratio of interestexpense to loans outstanding between companies having single bank vis-a-vismultiple banks are summarized in Table 2. From the table we can see thatthe sample mean of the companies having single bank is higher than that ofthe companies having multiple banks. The states of t- statistic and p-value in-dicates that the difference between these two categories of companies in ra-tio of interest expense to loans outstanding is not statistically significant (P=0.19), 5% level, and leads us not to reject the null hypothesis that there is nodifference between them.4. Summary and ConclusionWe have undertaken a modest attempt to check the impact of multiplebanking on the corporate borrows of Bangladesh. The results of the studymight be summarized and concluded as follows:(1) The analysis reveals that comparatively large banks, in terms of theshare of individual bank in total lending, have more single bankingrelationship with firms (see Figure 1). Thus it can be concluded thatlarge banks in Bangladesh seek to develop such kind of closer relation-ship as they can accommodate firms with the adequate amount of fundsto be their sole lending bank. Hence size of the bank also determinesMultiple Banking Practices and its Impact on the Corporate Borrowers- A Case Study of Bangladesh* - 255banks' ability to offer different broad range of services to promotelong-term relationship in Bangladesh.(2) Interest spread of the banking sector between lending and borrow-ing interest rate is as high as seven percent in Bangladesh. While theresult of the analysis shows that, banks which have the lendingrelationship with firms as sole lender possess lower interest spreadcompared to other banks (see Figure 3). But from the subsequent anal-ysis we have seen that, the interest expense of the firms borrowingfrom single lending banks is higher than that of the firms borrowingfrom multiple banks. Thus although the single lending banks are suc-cessful in reducing their net interest spread, this is not resulted inreducing interest cost of their borrowers. One reason for this might bethat, firms borrowing from single lending banks do not enjoy enoughfreedom to negotiate the interest rates of loans.(3) The results of the t-tests showed that, the average debt-equity ratio ofthe companies having borrowing relationship with single banks is higheras compared to that of the companies borrowing from multiple banks.This indicates that multiple banking makes access to credit difficult.On the other hand, the average interest expense to loans outstanding ratioof the companies having borrowing relationship with single banks ishigher as compared to that of the companies borrowing from multiplebanks. This indicates that by exploiting competition between banks,firms borrowing from multiple banks can borrow at lower cost.Thus from the result of the analysis we can conclude that, in Bangladeshmultiple banking practices present to lesser access to credit at comparativelylower cost. However, this area demands more detailed empirical analyseswith enough data support for our further research.256 KEIEI TO KEIZAINote*Weare grateful to Sonia Ahmed for assisting in data manipulation and to Safayet Rahmanfor helping in data collection.1) Multiple banking relationships imply that the company has borrowing relationship withtwo or more banks, but single banking relationship does that with only one bank.2) The term of single lender banks is used to refer to banks, which are providing loans tofirms as the only lending bank.3) See Levine et al. (2002).4) The negative mean value of Dept-equity ratio for multiple banks in Table 1 is due to thepresence of considerable number of firms having high accumulated loss figures. Theseloss figures made the total shareholders equity of the respective firms negative, as it in-cludes ordinary share capital, capital reserves and other reserves and retained earnings (posi-tive or negative balance of the profit and loss account).ReferencesAhmed, M. Farid (1997) Capital Markets and Institutions in Bangladesh: Some ImplicationsofJapanese Experience, Ashgate Publishing Ltd., England.Bangladesh Bank, Department of Public Relations and Publications, Economic Trends- Vari-ous Issues, Dhaka.--------------- (2001) Balance Sheet Analysis ofJoint Stock Companies, Dhaka.---------------Bangladesh Bank Bulletin, Various Issues, Dhaka.---------------Scheduled Bank Statistics, Various Issues, Dhaka.Cole, Rebel A. (1998) The importance of relationship to the availability of credit. Journal ofBanking & Finance, pp.959-977.Conigiliani, C., Ferri, G., Generale, A. (1997) The impact of bank-firm relations on thepropagation of monetary policy squeezes: An empirical assessment for Italy. BancaNazionale del Lavoro Quarterly Review, 202, pp.27l-299.D' Auria, c., Foglia, A., Marullo-Reedtz, P., (1999). Bank interest rates and credit relation-ships in Italy. Journal of Banking and Finance, Vol.23, Issue 7, pp. 1067-1093.Foglia, A., Laviola, S., Reedtz, P. M. (1998) Multiple banking relationship and the fragilityof corporate borrowers. Journal of Banking & Finance, Vol.22, Issues 10-11, pp.1441-1456.Multiple Banking Practices and its Impact on the Corporate Borrowers- A Case Study of Bangladesh* - 257Levine, D.M., Stephan, D., Drehbiel, T.e. and Berenson, M.L. (2002) Statistics forManagers. Third edition, Prentice Hall.Ministry of Planning, Government of Bangladesh, Bangladesh Bureau of Statistics (1997),Statistical Year Book of Bangladesh, Dhaka.--------------- (1999) Economic Survey of Bangladesh, Dhaka.Peterson, M.A., Rajan, KG. (1994) The benefits of lending relationships: Evidence fromsmall business data. Journal of Finance, 49, pp.3-37.Peterson, M.A., Rajan, KG. (1995) The effect of credit market competition on lendingrelationships. Quarterly Journal of Economics, 110, ppA07-443.Sachs, ]. D. and Larrain, F. B. (1993) Macroeconomics In The Global Economy, Prentice-HallInc: New Jersey, pp.139-40.Weinstein, D.E., Yafeh, Y. (1994) On the costs of a bank centered financial system: Evi-dence from the changing main bank relations in Japan. Presented at the CEPR Wor-kshop on Competing Models of Capitalism, Brussels, October 28-29.

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Multiple Banking Practices and its Impact on the Corporate Borrowers : A Case Study of Bangladesh

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