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Lines of Credit and Relationship Lending in Small Firm Finance

  • Allen Berger
  • Gregory Udell

This paper examines the role of relationship lending using a data set on small firm finance. The abilities to acquire private information over time about borrower quality and to use this information in designing debt contracts largely define the unique nature of commercial banking. Recently, a theoretical literature on relationship lending has appeared which provides predictions about how loan interest rates evolve over the course of a bank-borrower relationship. The study focuses on small, mostly untraded firms for which the bank-borrower relationship is likely to be important. The authors examine lending under lines of credit (L/Cs), because the L/C itself represents a formalization of the relationship and the data are thus more "relationship-driven." They also analyze the empirical association between relationship lending and the collateral decision. Using data from the National Survey of Small Business Finance, the authors find that borrowers with longer banking relationships pay a lower interest rate and are less likely to pledge collateral. Empirical results also suggest that banks accumulate increasing amounts of this private information over the duration of the bank-borrower relationship.

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File URL: http://fic.wharton.upenn.edu/fic/papers/94/9411.pdf
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Paper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 94-11.

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Date of creation: Mar 1994
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Handle: RePEc:wop:pennin:94-11
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  1. 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.
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  18. Berger, Allen N. & Udell, Gregory F., 1990. "Collateral, loan quality and bank risk," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 21-42, January.
  19. Sharpe, Steven A, 1990. " Asymmetric Information, Bank Lending, and Implicit Contracts: A Stylized Model of Customer Relationships," Journal of Finance, American Finance Association, vol. 45(4), pages 1069-87, September.
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  22. Thakor, Anjan V., 2000. "Relationship Banking," Journal of Financial Intermediation, Elsevier, vol. 9(1), pages 3-5, January.
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  25. Allen, Linda & Saunders, Anthony & Udell, Gregory F., 1991. "The pricing of retail deposits: Concentration and information," Journal of Financial Intermediation, Elsevier, vol. 1(4), pages 335-361, December.
  26. Boot, Arnoud W A & Thakor, Anjan V & Udell, Gregory F, 1991. "Secured Lending and Default Risk: Equilibrium Analysis, Policy Implications and Empirical Results," Economic Journal, Royal Economic Society, vol. 101(406), pages 458-72, May.
  27. James, Christopher, 1987. "Some evidence on the uniqueness of bank loans," Journal of Financial Economics, Elsevier, vol. 19(2), pages 217-235, December.
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  29. Mark Carey S. & Stephen Prowse & John Rea & Gregory Udell, 1993. "The economics of the private placement market," Staff Studies 166, Board of Governors of the Federal Reserve System (U.S.).
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  31. Takeo Hoshi & Anil Kashyap & David Scharfstein, 1989. "Bank monitoring and investment: evidence from the changing structure of Japanese corporate banking relations," Finance and Economics Discussion Series 86, Board of Governors of the Federal Reserve System (U.S.).
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