RELATIONSHIP AND TRANSACTION L ENDING IN A CRISIS Patrick Bolton (Columbia Business School) Xavier Freixas ( Universitat Pompeu Fabra ) Leonardo Gambacorta (BIS) Paolo Emilio Mistrulli ( Bank of Italy ) LUISS , 7 March 2016 The views expressed in the following do not necessarily reflect those of the Bank for International Settlements or the Bank of Italy
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The views expressed in the following do not necessarily reflect those ofthe Bank for International Settlements or the Bank of Italy
AdefinitionofRELATIONSHIPLENDING
l Boot(2000),“RelationshipBanking:WhatDoWeKnow?”,JournalofFinancialIntermediation,9,3-25.
“…the provision of financial services by a financialintermediary that invests in obtaining customer-specificinformation, often proprietary in nature…and evaluates the profitability of these investmentsthrough multiple interactions with some customer overtime and/or across products” (p.10)
Relationship lending theories What are the benefits of relationship lending?
1. Risk-sharing (implicit insurance)
Berger and Udell (1992), Berlin and
Mester (1999) Buying insurance regarding future access to credit
2. Interim monitoring (moral hazard)
Holmstrom and Tirole, (1997)
Only firms that don't have a sufficient stake in the project ask for a monitored bank loan, while firms with sufficient cash (or collateral) will prefer arm's length financing (transactional loans). Relationship banks' recognize the firms' type and monitoring is simply a way to limit the moral hazard problem.
3. Ex-ante screening (adverse
selection)
Agarwal and Hauswald (2010), Puri et
al. (2010)
Relationship banks may be better able to ex-ante screen the firms. The comparative advantage for relationship banks lead to an ex-post monopoly of information.
4. Learning
Rajan (1992), von Tadden (1995),
this paper.
Relationship banks do not know the firm type at the beginning but can learn it by monitoring. Monitoring is costly and this is reflected in higher lending rates in good times. However, in bad times R-banks have a strong incentive to shield the clients in order not to waste the information investment (and the sunk cost sustained).
Maincharacteristicsofthetheoreticalmodel
Themodel(1)• Extension of Bolton and Freixas (2006), which consider firms'
choice of the optimal mix of financing between borrowing froma relationship bank (R-bank) and issuing a corporate bond.Two key modifications:
§ Financial support is sure for H-firms contracting with R-banks, while itdepends on the state of the economy for the firms -of all types-contractingwith T-banks.
“It does exist a critical threshold for the expected (in t=0) probability of success in bad time �̂�) such that for any 𝑝 > �̂�) firms prefer pure transactional banking and for any 𝑝 < �̂�) firms prefer to combine transactional and relationship banking (mixed finance)”
Interestratesettingbybank’stypeandstateoftheworld
• The cost of credit of transactional lending is always lower than relationship banking in good times. This pattern is reversed in bad times. In line with the model, it is always cheaper for safe firms to use T-banks.
The horizontalaxisreportstheZ-score, anindicatoroftheprobabilityofdefaultoffirms.These scores canbemappedintofourlevelsofrisk:1)safe; 2)solvent;3)vulnerable;4)risky.Theverticalaxisindicatetheleveloftheinterestrate appliedbythetwo bank typesoncreditlinestothe4groupsoffirms.
(a1) Interest rate: good times (2007:q2) (a2) Interest rate: bad times (2010:q1)
Lendingbybank’stypeandstateoftheworld
• The roll-over effects of R-banks on lending is in place prevalently for risky firms while safe firms obtain always a greater level of financing from T-banks both in good and bad times.
The horizontalaxisreportstheZ-score, anindicatoroftheprobabilityofdefaultoffirms.These scores canbemappedintofourlevelsofrisk:1)safe; 2)solvent;3)vulnerable;4)risky.Theverticalaxisindicatethelogoflendinginrealtermssuppliedbythetwobanktypes.
(b1) Lending: good times (2007:q2) (b2) Lending: bad times (2010:q1)
Testforhypothesis4:(CapitalBuffer)
“R-banks need a larger capital buffers to preserve lending relationship in bad times”
Bankcapitalandrelationshiplending(1)
A pure T-bank that have a credit portfolio composed exclusively oftransactional loans (T-share =1) have a capital buffer around 3 percentagepoints lower than a pure R-bank (T-share=0).
Dependent variable is regulatory capital-to-
risk weighted assets of bank j at 2008:q2
Baseline model
(I)
Bank-specific
characteristics
(II)
Firm-specific
characteristics
(III)
Financially
constrained firms
(IV)
T-share -3.839*** -2.992** -3.154** -3.231**
(0.890) (1.344) (1.307) (1.308)
Bank size 0.181 0.038 0.068
(0.402) (0.390) (0.375)
Bank liquidity ratio -0.015 -0.010 -0.003
(0.018) (0.019) (0.018)
Retail ratio 0.054*** 0.030* 0.029*
(0.018) (0.017) (0.017)
Characteristics of banks’ credit portfolios yes yes
l From a policy point of view the results of the paper extend the needof capital buffers not only to protect depositors but also to allowrelationship banks to shield their clients in case of an adverseshocks
AnnexA comparison with the predictions of other models
Predictionsofrelationshipbankingmodels
§ Use the results for test of prepositions 1 and 2.§ Preposition 1 on firms' default probability. § Preposition 2 on how R and T banks set their interest rates.
Possible explanations of
relationship vs transactional
lending
I.
Delinquency rate
II.
Lending rates
III.
Lending quantities
Bad time Good time Bad time Good time Bad time
1. Risk-sharing R=T R>T R>T R>T R>T
2. Interim monitoring R>T R>T R>T ? ?
3. Ex-ante screening R<T R>T R>T R=T R=T
4. Learning R<T R>T R<T ? ?
Notes: R= Relationship bank (R-bank); T= Transaction bank (T-bank)
Step1:Resultsondefaultprobabilities
§ Test on Hypothesis 1: Defaults are lower for R-banks
§ This is consistent with two possible explanations of the nature of relationship lending, namely "learning" and "ex-ante screening“: in both cases R-banks are better able than T-banks in learning firms’ type.
Possible explanations of
relationship vs transactional
lending
I.
Delinquency rate
II.
Lending rates
III.
Lending quantities
Bad time Good time Bad time Good time Bad time
1. Risk-sharing R=T R>T R>T R>T R>T
2. Interim monitoring R>T R>T R>T ? ?
3. Ex-ante screening R<T R>T R>T R=T R=T
4. Learning R<T R>T R<T ? ?
Notes: R= Relationship bank (R-bank); T= Transaction bank (T-bank)
Step2:Analysisoninterestrates
§ Test on Hypothesis 2: R-banks ask for higher interest rates in good time but reduce cost in bad time to preserve lending relationship.
§ Results are consistent only with the “learning” hypothesis.
Possible explanations of
relationship vs transactional
lending
I.
Delinquency rate
II.
Lending rates
III.
Lending quantities
Bad time Good time Bad time Good time Bad time
1. Risk-sharing R=T R>T R>T R>T R>T
2. Interim monitoring R>T R>T R>T ? ?
3. Ex-ante screening R<T R>T R>T R=T R=T
4. Learning R<T R>T R<T ? ?
Notes: R= Relationship bank (R-bank); T= Transaction bank (T-bank)