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Relationship loans and information exploitability in a competitive market: loan commitments vs. spot loans

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  • Ozgur Emre Ergungor
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    Abstract

    Despite the numerous benefits of loan commitments, only 79% of the commercial and industrial loans are made under commitment. I show that two factors limit the use of loan commitments. First, because banks commit themselves to lend, they carry costly liquidity reserves to meet their obligations. Due to liquidity costs, the interest rate on commitment loans is high relative to spot loans. Second, high interest rates trigger moral hazard. If the bank expects a profitable relationship in the future, it can absorb a portion of the liquidity costs to reduce the interest rate and attenuate moral hazard. If not, the borrower cannot get a loan commitment.

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    File URL: http://www.clevelandfed.org/research/workpaper/2000/Wp0013.pdf
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    Bibliographic Info

    Paper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 0013.

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    Date of creation: 2000
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    Handle: RePEc:fip:fedcwp:0013

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    Keywords: Bank loans;

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    2. Stanley D. Longhofer & João A.C. Santos, 1998. "The importance of bank seniority for relationship lending," Working Paper 9808, Federal Reserve Bank of Cleveland.
    3. Chan, Yuk-Shee & Thakor, Anjan V, 1987. " Collateral and Competitive Equilibria with Moral Hazard and Private Information," Journal of Finance, American Finance Association, vol. 42(2), pages 345-63, June.
    4. Anjan V. Thakor & Gregory F. Udell, 2004. "An Economic Rationale for the Pricing Structure of Bank Loan Commitments," Finance 0411053, EconWPA.
    5. Anjan V. Thakor & Hai Hong & Stuart I. Greenbaum, 2004. "Bank Loan Commitments and Interest Rate Volatility," Finance 0411050, EconWPA.
    6. Blackwell, David W & Winters, Drew B, 1997. "Banking Relationships and the Effect of Monitoring on Loan Pricing," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 20(2), pages 275-89, Summer.
    7. Anil K. Kashyap & Raghuram Rajan & Jeremy C. Stein, 1999. "Banks as Liquidity Providers: An Explanation for the Co-Existence of Lending and Deposit-Taking," NBER Working Papers 6962, National Bureau of Economic Research, Inc.
    8. Mitchell A. Petersen & Raghuram G. Rajan, 1994. "The Effect of Credit Market Competition on Lending Relationships," NBER Working Papers 4921, National Bureau of Economic Research, Inc.
    9. Boot, Arnoud & Thakor, Anjan V. & Udell, Gregory F., 1987. "Competition, risk neutrality and loan commitments," Journal of Banking & Finance, Elsevier, vol. 11(3), pages 449-471, September.
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    15. Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, vol. 47(4), pages 1367-400, September.
    16. Stuart I. Greenbaum & Itzhak Venezia, 1985. "Partial Exercise Of Loan Commitments Under Adaptive Pricing," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 8(4), pages 251-263, December.
    17. Besanko, David & Thakor, Anjan V, 1987. "Collateral and Rationing: Sorting Equilibria in Monopolistic and Competitive Credit Markets," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(3), pages 671-89, October.
    18. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-55, September.
    19. Boot, Arnoud W A & Greenbaum, Stuart I & Thakor, Anjan V, 1993. "Reputation and Discretion in Financial Contracting," American Economic Review, American Economic Association, vol. 83(5), pages 1165-83, December.
    20. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
    21. Shockley Richard L., 1995. "Bank Loan Commitments and Corporate Leverage," Journal of Financial Intermediation, Elsevier, vol. 4(3), pages 272-301, July.
    22. Melnik, Arie & Plaut, Steven E., 1986. "The economics of loan commitment contracts: Credit pricing and utilization," Journal of Banking & Finance, Elsevier, vol. 10(2), pages 267-280, June.
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