Relationship and Transaction Lending in a Crisis

We study how relationship lending and transaction lending vary over the business cycle. We develop a model in which relationship banks gather information on their borrowers, which allows them to provide loans for profitable firms during a crisis. Due to the services they provide, operating costs of relationship-banks are higher than those of transaction-banks. In our model, where relationship-banks compete with transaction-banks, a key result is that relationship-banks charge a higher intermediation spread in normal times, but offer continuation-lending at more favorable terms than transaction banks to profitable firms in a crisis. Using detailed credit register information for Italian banks before and after the Lehman Brothers' default, we are able to study how relationship and transaction-banks responded to the crisis and we test existing theories of relationship banking. Our empirical analysis confirms the basic prediction of the model that relationship banks charged a higher spread before the crisis, offered more favorable continuation-lending terms in response to the crisis, and suffered fewer defaults, thus confirming the informational advantage of relationship banking.