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The relationship banking paradox: No pain no gain versus raison d'être

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  • Dong, Baomin
  • Guo, Guixia

Abstract

Relationship banking paradox refers to the case that credit market competition may threaten relationship banking practice, but it may stimulate it as well because of differentiation. Using a mixed model of adverse selection and double moral hazard, this paper shows that for some parameter values, relationship banking arises even when the banks compete à la Bertrand, hence supporting the no pain no gain hypothesis. This is due to multilayer nature of the information asymmetry by double moral hazard where an outside bank that does not have the borrower's proprietary information is unable to exert optimal levels of effort in the continuation game.

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Bibliographic Info

Article provided by Elsevier in its journal Economic Modelling.

Volume (Year): 28 (2011)
Issue (Month): 5 (September)
Pages: 2263-2270

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Handle: RePEc:eee:ecmode:v:28:y:2011:i:5:p:2263-2270

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Web page: http://www.elsevier.com/locate/inca/30411

Related research

Keywords: Relationship banking Adverse selection Moral hazard;

References

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  1. Bhattacharya Sudipto & Chiesa Gabriella, 1995. "Proprietary Information, Financial Intermediation, and Research Incentives," Journal of Financial Intermediation, Elsevier, vol. 4(4), pages 328-357, October.
  2. Berger, Allen N & Udell, Gregory F, 1995. "Relationship Lending and Lines of Credit in Small Firm Finance," The Journal of Business, University of Chicago Press, vol. 68(3), pages 351-81, July.
  3. Janne Peltoniemi, 2007. "The Benefits of Relationship Banking: Evidence from Small Business Financing in Finland," Journal of Financial Services Research, Springer, vol. 31(2), pages 153-171, June.
  4. Steven A. Sharpe, 1989. "Asymmetric information, bank lending, and implicit contracts: a stylized model of customer relationships," Finance and Economics Discussion Series 70, Board of Governors of the Federal Reserve System (U.S.).
  5. Arnoud W. A. Boot & Anjan V. Thakor, 2000. "Can Relationship Banking Survive Competition?," Journal of Finance, American Finance Association, vol. 55(2), pages 679-713, 04.
  6. Petersen, Mitchell A & Rajan, Raghuram G, 1995. "The Effect of Credit Market Competition on Lending Relationships," The Quarterly Journal of Economics, MIT Press, vol. 110(2), pages 407-43, May.
  7. Petersen, Mitchell A & Rajan, Raghuram G, 1994. " The Benefits of Lending Relationships: Evidence from Small Business Data," Journal of Finance, American Finance Association, vol. 49(1), pages 3-37, March.
  8. Bolton, Patrick & Scharfstein, David S, 1996. "Optimal Debt Structure and the Number of Creditors," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 1-25, February.
  9. Dewatripont, M & Maskin, E, 1995. "Credit and Efficiency in Centralized and Decentralized Economies," Review of Economic Studies, Wiley Blackwell, vol. 62(4), pages 541-55, October.
  10. Giovanni Dell'Ariccia & Ezra Friedman & Robert Marquez, 1999. "Adverse Selection as a Barrier to Entry in the Banking Industry," RAND Journal of Economics, The RAND Corporation, vol. 30(3), pages 515-534, Autumn.
  11. Boot, Arnoud W. A., 2000. "Relationship Banking: What Do We Know?," Journal of Financial Intermediation, Elsevier, vol. 9(1), pages 7-25, January.
  12. Boot, Arnoud W. A & Schmeits, Anjolein, 1998. "Challenges to competitive banking: a theoretical perspective," Research in Economics, Elsevier, vol. 52(3), pages 255-270, September.
  13. Diamond, Douglas W, 1991. "Monitoring and Reputation: The Choice between Bank Loans and Directly Placed Debt," Journal of Political Economy, University of Chicago Press, vol. 99(4), pages 689-721, August.
  14. Degryse, Hans & Ongena, Steven, 2007. "The impact of competition on bank orientation," Journal of Financial Intermediation, Elsevier, vol. 16(3), pages 399-424, July.
  15. Jun, Byoung & Vives, Xavier, 2004. "Strategic incentives in dynamic duopoly," Journal of Economic Theory, Elsevier, vol. 116(2), pages 249-281, June.
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Cited by:
  1. Gajewski, Krzysztof & Pawłowska, Małgorzata & Rogowski, Wojciech, 2012. "Relacje firm z bankami w Polsce w świetle danych ze sprawozdawczości bankowej
    [Bank-firm relationships in Poland in the light of data from bank reporting]
    ," MPRA Paper 42544, University Library of Munich, Germany, revised 29 Oct 2012.

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