Relationship Banking, State Co-Ordination and Long-Term Debt: Reinterpreting the Big Push

Abstract

We develop a lending game in which relationship-specific investments by firms benefit banks and vice versa. We show that even if all firms and banks prefer high-tech relationship loans under the first-best, asymmetric information and investment non-contractibility make them choose low-tech transaction loans. However, governments with intermediate risk ratings can use Groves subsidies for a concerted switch to long-term relationship loans. To avoid premature liquidation, they finance the scheme with long-term foreign debt. Thus, we try to explain the positive correlation between subsidies and long-term domestic and foreign debt, which was a salient feature of the East Asian development experience.Relationship Banking; Groves Subsidies; Intermediate Rating; Long-term Debt