The Benefits of lending Relationships: Evidence from Small Business Data
Mitchell Petersen and Raghuram Rajan
JF March 1994
Executive Summary: Banking relationships (either measured by number of years or number of banks for which the firm has loans from) are beneficial to small firm both in the form of better credit availability as well as a lower interest rate.
Due to costs of producing information about the credit worthiness of a firm, it is hypothesized that maintaining a lending relationship (which allows the bank to amortize the costs over multiple transactions) may lower the cost of debt and increase the availability of loans.
This paper builds on the idea that Japanese firms in Keiritsus (see Hoshi, Kashyap, and Scarfstein 1991) have better access to funds and lower costs of financial distress. In the Unites States, James (1987), Lummer and McConnell (1989), James and Wier (1990), and Shockley and Thankor (1992) show that the existence or renewal of a banking relationship or loan commitment is a positive stock market event.
This paper uses more detailed data on the strength of the relationship and it "estimates the effects of the relationship on both the availability and the price of credit.
Data: 3,404 firms (1875 are corporations) from the National Survey of Small Business by the US Small Business Administration (SBA). Small firms are those with fewer than 500 employees. The response rate was about 70-80%.
As expected smaller firms were in the service industries and the firms tended to be younger (median age about 10 years). Found very little difference in leverage when looking at corporations vs. non-corporations.
Smaller firms were more apt to borrow from owner and family whereas larger firms were more likely to borrow from banks. (table II) "Firms tend to concentrate their borrowing from one source, though this concentration decreases with firm size." (Table III) This is "one measure of how close a firm is to its main lender."
When personal and family loans are excluded, banks make 82% of the loans. At the time the average interest rate was 11.3% with a standard deviation of 2.2%. "This is 4.1% above government bonds of similar maturity, 2.4% above the prime at the time the loans were made, and 10 basis points the yield on BAA corporate bonds."
Cost of credit
Interest rates on a loan were a modeled as
Bo
+ B1 (Economy-wide interest rate variable
+ B2 (Firm Characteristics)
+ B3 (Loan and Lender Characteristics)
+ B4 (Region and Industry Dummies)
+ B5 (relationship characteristics)
| Economy-wide Characteristics | Firm Characteristics | Loan characteristics | Industry | Relationship Characteristics |
| Prime rate Term structure Default spread |
Log(assets) Corporation(0,1) Sales Growth Profits/Interest |
Floating Loan Bank Loan Non-financial firm loan |
ROA for industry | Length of relationship (yrs) Firm age Deposit accounts with lender Number of banks from which firm borrows |
| Prime rate and default spread significant | Size and Corporation dummy negative and significant | Floating rate and non financial firm are both negative and significant | Insignificant | Firm age is significantly negative # of banks is positive and significant |
The more banks the firm borrowed from (hence the less stable of relationship) the higher the rate charged. Specifically the authors find a 31 basis point increase in interest rate for each additional bank. (Of course this could be an endogenity problem since it is possible these firms shop around because they are higher risk, but hopefully the many variables included in the regression capture this risk.)
Availability of credit
Difficult to measure as debt ratios understate true availability but may be the best available information. Additional problem is that it is impossible to tell if low debt is a result of low demand for debt or low availability.
Looking at debt/assets the authors find larger firms do have more debt, but that older and more profitable firms (which it could be argued should have more debt have less debt.
One way to get at this is to look at discount "stretch" a measure of how long a firm holds A/P before paying them. The authors find this to be from 62 to 1 day. Since by doing this they forgo the substantial discount, this suggests that credit is not available from other sources. (problems abound in this as it assumes constant sales etc).
The authors find convincing evidence that firms with better relationships (either longer or those that borrow from fewer banks) pay their A/P sooner and hence take advantage of lower interest rate. This suggests that these firms have more access to the external funds.
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