PART III: THE GATEKEEPING ROLE OF FINANCIAL INTERMEDIARIES
B. Main characteristics of relationship lending
II. Long-term relations and flexibility in renegotiations
of borrower credit quality due to deterioration in bank screening and monitoring, although unambiguous evidence regarding this correlation is still incomplete.1073
borrowers not only in the form improved loan terms and rates, but also in the availability of credit when conditions in the loan market otherwise deteriorate.1078 It is typical in this type of lending relationships that loan terms are stringent, including restrictive covenants, at the beginning of the relationship, but they soften over time, once the creditworthiness of the borrower as well as the quality of her projects are established.1079 This conclusion about exclusive lending relationship seems to be in line with findings in other studies that claim that the value of borrower proprietary information is highest when the borrower does not diversify her borrowing sources.1080 Since exclusive long-term lending relationship imply an information-intensive relationship between borrower and lender it is reasonable to suggest the presence of relationship lending in this case. However, although borrowers seldom maintain exclusive lending relationships,1081 studies suggest that the benefits from long-term lending relationships exist also when the lending bank is the premier lender of the borrower, but not necessarily the exclusive one.1082 For example, Elsas/Krahnen in their analysis define the premier lender as the borrower’s “housebank”,1083 being equipped with more relevant and timelier information about the borrower than any “normal” non-housebank institution.1084 They find that even in the presence of competition from other lenders, housebanks provide a kind of liquidity insurance in situations where the borrower faces an unexpected deterioration of her rating,1085 supporting thus suggestions made earlier that borrowers benefit from credit availability.
1078 Berlin, Business Review of the Federal Reserve Bank of Philadelphia, 1996, 1, p. 2-3.
1079 Ibid., p. 3.
1080 See e.g. Petersen/Rajan, Journal of Finance, 1994, 3.
1081 Elsas/Krahnen, Journal of Banking and Finance, 1998, 1283, p. 1286.
1082 See e.g. Elsas/Krahnen, Journal of Banking and Finance, 1998, 1283.
1083 Housebank relationships are typical in Germany. See Edwards/Fischer, Banks; Brackschulze, Funktionen und Strategien von Hausbanken unter Basel II, 2009 (hereinafter „Brackschulze, Hausbanken unter Basel II“), p. 1.
1084 Elsas/Krahnen, Journal of Banking and Finance, 1998, 1283, p. 1284. See also Elsas, Die Bedeutung der Hausbank. Eine ökonomische Analyse, 1. Aufl., 2001 (hereinafter “Elsas, Hausbank”), p. 12 for a more detailed description of the characteristics of a housebank relationship. Apart from informational advantages, other characteristics include the larger (dominating) part of credit that housebanks hold compared to other lenders, the long term nature of the lending relationship as well as the special trust relationship existing between the lender and the borrower, and last but not least the “special responsibility” that the relationship lender carries when the relationship borrower faces a financial crisis.
1085 Elsas/Krahnen, Journal of Banking and Finance, 1998, 1283, p. 1285. However, the liquidity insurance is not unconditional and it will depend on the magnitude of the change of the creditworthiness. For changes up to one notches, relationship lenders will continue to provide funding, whereas if the credit rating deteriorates by two or more notches, financial commitment from lenders is interrupted, including also relationship lenders.
b) Lower loan rates
Further studies have found also a negative correlation between loan rates and the duration of the lending relationship, suggesting that long-term lending relationships reduce information asymmetries between borrowers and lenders, and contribute thus in the reduction of borrower’s credit risk.1086 Moreover, long-term relationships might result beneficial also when a debt renegotiation is necessary. A number of authors suggest that a long-term commitment of a borrower facilitates debt renegotiations by lenders who might be willing to forfeit profit in the short run in return for sufficient compensation in the long run.1087 The same approach to loss subsidisation, known also as an “intertemporal smoothing of contract terms”1088 can be observed also when banks lend to de novo borrowers. However, this might be true for non-competitive loan markets. In highly competitive loan markets ‘banks do not have the luxury of taking temporary losses in the expectation of charging relatively high interest rates in the future’1089 since they need to cover lending costs on a period by period basis.
c) Flexible debt contracts
Regarding the flexibility of debt contracts, the fact that parties involved in a loan agreement is limited compared to a bond issue and that the relationship is close and information-intensive, it should enable the parties to draft contracts that reflect their concerns. Covenants accompanying loan agreements can be drafted in such a way as to contain the requirements that both lender and borrower find necessary to guide their relationship. Moreover, due to the continuous flow of borrower information, covenants may be altered to reflect the changes in the borrower’s financial situation.
2. Potential costs from long-term lending relations a) Soft-budget constraint problem
On the costs side, the so-called soft-budget constraint problems are typical. Lenders, who maintain a long-term and close relationship with the borrower, might find it difficult to deny credit to a borrower that is facing financial distress. Although the question whether or not to
1086 See e.g. Harhoff/Körting, Journal of Banking and Finance, 1998, 1317, on the reduction of information asymmetries and Boot/Thakor, International Economic Review, 1994, 899, and Berger/Udell, The Economic Journal, 2002, F32–F53, on the negative correlation between loan rates and length of lending relationship. However, see also Petersen/Rajan, Journal of Finance, 1994, 3, who find no significant influence of the length of the lender’s relationship with the borrower on the rate of loan.
1087 See e.g. Petersen/Rajan, Quarterly Journal of Economics, 1995, 407; Harhoff/Körting, Journal of Banking and Finance, 1998, 1317, and Boot, Journal of Financial Intermediation, 2000, 7.
1088 Boot, Journal of Financial Intermediation, 2000, 7, p. 15.
1089 Berlin, Business Review of the Federal Reserve Bank of Philadelphia, 1996, 1, p. 4.