When in Rome: lending to SMEs by foreign and domestic banks

Conditional on a loan application filed by a small or medium enterprise (“SME”), we find that the existence of recent loans of that firm with private domestic banks increases the chance a loan will be granted by a foreign bank relative to a private domestic bank. On the other hand, recent loans extended by foreign banks or by domestic state-owned banks do not produce this differential effect. Furthermore, the forementioned effect vanishes for large firms. These findings are consistent with a mechanism by which foreign banks overcome borrower informational asymmetries by relying on their domestic peers’ recent behavior. Indeed, the higher ability of private domestic banks to access informationally opaque SMEs, dependent on soft information, makes recent loans with them a more valuable signal for foreign lenders who lack the same ability.