Small business credit availability and relationship lending

small business credit availability and relationship lending

exclusion during crises requires either relationship lending or enticing . technologies include financial statement lending, small business credit scoring, asset-. This paper adds to the relationship lending debate by investigating detailed contract information of political concern over small business credit availability. Small business credit availability is one of the major issues policy makers have . relationship between bank size and small business lending that suggests that .

Chakravarty and Xiang also find that discouraged borrowers in underdeveloped countries have relationships with fewer banks. Finally, Bonnet, Cieply and Dejardin find that discouraged borrowers have highly developed relations with banks.

We offer here a brief survey of publications linking bank relationships to the availability of financing.

small business credit availability and relationship lending

The general idea is that a stronger relationship gives more information to the bank and allows it to take a better decision. While Berger and Udell show that firms with longer relationships with banks enjoy better lending conditions, Petersen and Rajan are the first to link explicitly the lending relationship with financing availability. Using the NSSBFPetersen and Rajan find that longer banking relationships and concentrated financial markets increase the availability of funds, while the number of financial intermediaries decreases it.

The intuition underlying the first finding is that longer relationships chip at the information asymmetry separating borrower and bank, and the fact that financial institutions need a monopolistic position for it to be worthwhile for them investing in a relationship explains the second and third finding. The authors use late repayment of trade credit as a signal that firms have difficulty receiving conventional and cheaper financing. Cole turns away from trade credit to consider the actual acceptance decisions of banks reported in the NSSBF He finds, among other things, that the length of the relationship does not play as much a role as the sheer existence of a relationship.

Chakravarty and Yilmazer complements these results using the NSSBF by showing that the total number of savings accounts and the number of loans at a potential lending institution affect only the application and acceptance rate, but not the cost of financing.

There is certainly evidence that relationships play a role in financing decisions, but it is unclear in which settings. Berger and Udell argue for the importance of the small size of financial institutions and for decentralisation in order to enable relationship lending. Finally, Lehman and Neuberger address the issue of decentralisation by considering the relationship between SME and account manager.

In addition to the usual variables, which proxy for the relationship between bank and SMEthey include the following variables that describe the relationship between the account manager and the SME: Of those, both the positive experience and the willingness to inform play an important role in the decision of the bank to award credit.

In this paper, we combine the relationship lending and discouraged borrower literatures. The idea is that banks are not the only ones collecting information through stronger relationships; SMEs also gain information about themselves and about their bank through the same process.

Just like Colewe not only compare discouraged borrowers with applicants, but also with denied borrowers. In this analysis we include variables that account for the length of the relationship between the bank and the SME following Petersen and Rajan Furthermore, we also consider a variable that determines if the SME has a designated account manager along the lines of Cole to see if a relationship exists. We also include variables that describe the relationship between account manager and SME as in Lehman and Neuberger Finally, we use the satisfaction of SMEs concerning convenience and accessibility and service charges to proxy for application cost as suggested by Kon and Storey The main objective of this survey is to determine what type of SMEs request financing in the form of debt, leasing, equity and trade credit, and which SMEs are approved.

small business credit availability and relationship lending

The survey also contains some general information concerning the SMEthe banking relationship, and some financial information. Footnote 2 We define discouraged borrowers as those who do not apply for one of the three following reasons: The first reason is the traditional one, while the two last reasons correspond to problems related to application costs as discussed by Kon and Storey as a cause for discouragement.

Applicants are SMEs that applied for one of the following financing forms: Denied SMEs did not receive any financing from these four means, while approved SMEs received some from any one of them. Denied borrowers outnumber discouraged borrowers by almost 3 to 1. If we only consider debts financing, the ratio goes down to 2 to 1. This latter ratio is the same as the one reported by Chakravarty and Yilmazer Methodology To explain discouragement, we use the following four blocks of explanatory variables: The following paragraphs will detail the content of the four blocks.

A strong relationship would help both parties overcome the information asymmetry. As much as the account manager would learn about the SMEthe SME would also gain knowledge on the criteria used by the account manager. We use the satisfaction for five criteria: Each of the five criteria is rated on a Likert scale from 1 to 7 — seven being the highest satisfaction. According to our hypothesis that discouraged borrowers are simply more realistic, we expect discouraged borrowers to have a higher satisfaction with respect to the relationship with the account manager and overall quality of service.

If the application cost explanation is valid, variables like convenience or service charges will be significant and negative when explaining discouragement. If discouraged borrowers are indeed victims, their satisfaction will be generally low. Second, as reported in Berger and Udellthe decentralization of approval decisions gives more weight to relationship lending. Consequently, we use a dummy variable for the usage of a credit union as main financial intermediary.

In Canada, the six most important banks occupy 90 percent of the market calculated in assets Allen and Engert, and approximately 65 percent of the Canadian portfolio Industry Canada, p. Credit unions, therefore, play the role of small banks in the US. Other forms of financing are similarly less common for startups than is perceived, as entrepreneurs face greater obstacles to raising external funds than do established companies.

Since young firms typically do not have an informative record, they are unable to access public equity or bond markets. In addition to being insufficiently informed, arm's length investors are usually too distant and dispersed to monitor the entrepreneur's use of funds.

As a result, banks have emerged as intermediaries that specifically screen and monitor firms in order to bridge the divide between entrepreneurs with ideas and investors with capital. With the exception of high-tech startups that usually require venture-capital financing, banks are traditionally the most important providers of capital for small, entrepreneurial firms.

One prominent feature of bank lending to entrepreneurs is that it is typically carried out by smaller banks. Banks vary in the type of information they use to evaluate borrowers. Large banks specialize in transaction lending that depends on "hard" information, such as audited financial statements. Fledgling businesses often do not have verified statements or, in the earliest stages, even realized cash flows to report. Consequently, determining these firms' creditworthiness requires producing "soft" information about the firm, including assessments of management quality, borrower characterand other risk factors that are difficult to quantify.

This type of lending is the comparative advantage of smaller banks for at least two reasons. First, smaller banks have the proximity to engage in close, repeated interaction with the entrepreneur. The benefits of bank relationships also increase in the extent to which the entrepreneur generates additional profit for the bank by buying non-credit services e. A third important factor that affects bank lending to entrepreneurs is competition.

Here, the evidence is more mixed.

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Conventional wisdom would suggest that more competition in a market would lead to reduced prices and make customers better off; however, this market-power reasoning does not account for the critical role relationships play in the market for bank loans to potential entrepreneurs.

In competitive markets where firms face alternative sources of credit, banks would not be able to offer low prices to entrepreneurs because they would lack the market power to recover their investment by charging higher prices in the future. In a cross-sectional analysis, they show that interest rates on bank loans fall more slowly with the age of the relationship in concentrated markets than in more competitive markets.

small business credit availability and relationship lending

Other evidence suggests that entrepreneurs could benefit from competitive credit markets instead. There are many important questions moving forward.

small business credit availability and relationship lending

Bank financing seems to be important for startups during their first few years of existence, as founders go back to banks to raise additional capital as they continue to grow. This suggests that many startups are initially constrained in the amount they can borrow. Future Research Convincing a bank of credit quality absent audited financials requires close, repeated interaction. If the firm were to switch banks, it would have to start from scratch with a new bank and might suffer in the process.

This is an area where empirical evidence is lacking.

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