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A Quantitative Theory of Relationship Lending

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Abstract

Borrower-lender relationships tend to be long-lasting, and borrowers switch lenders infrequently. We analyze the aggregate consequences of these facts in a model of heterogeneous banks subject to financial frictions that incorporates lending relationships as a form of customer capital for banks. The model's loan demand system is directly estimated on administrative loan-level data to recover key parameters governing the strength and persistence of relationships. The degree of market power deriving from lending relationships is consistent with a long run reduction in total credit of 4.1% relative to a competitive benchmark. We find that financial and relationship capital are complements, and therefore correlated across banks in equilibrium. Relationship lending amplifies the negative real effects of credit supply shocks, but allows banks to rebuild their buffers faster: in response to an unanticipated 25% drop in bank net worth, loan volume drops 36% more in our baseline model than in a competitive analog with no relationships. In contrast, relationship lending mutes the contractionary real effects of negative credit demand shocks.

Suggested Citation

  • Kyle Dempsey & Miguel Faria-e-Castro, 2022. "A Quantitative Theory of Relationship Lending," Working Papers 2022-033, Federal Reserve Bank of St. Louis, revised 19 Mar 2024.
    • Handle: RePEc:fip:fedlwp:94821
    DOI: 10.20955/wp.2022.033
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    1. Javier Bianchi & Saki Bigio, 2022. "Banks, Liquidity Management, and Monetary Policy," Econometrica, Econometric Society, vol. 90(1), pages 391-454, January.
    2. Mark Egan & Ali Hortaçsu & Gregor Matvos, 2017. "Deposit Competition and Financial Fragility: Evidence from the US Banking Sector," American Economic Review, American Economic Association, vol. 107(1), pages 169-216, January.
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    5. Berlin, Mitchell & Mester, Loretta J., 1998. "On the profitability and cost of relationship lending," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 873-897, August.
    6. 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 351-381, July.
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    More about this item

    Keywords

    banking; lending relationships; aggregate dynamics;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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