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Journal of Financial Services Research

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05-01-2021

Relationship Lending and Switching Costs under Asymmetric Information about Bank Types

Author: J.-P. Niinimäki

Published in: Journal of Financial Services Research | Issue 1/2022

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Abstract

This theoretical paper extends the pioneering articles on relationship lending (e.g., Sharpe. J Finance XLV(4): 1069-1087, 1990; Rajan. J Financ 47: 1367–1400, 1992; von Thadden. Financ Res Lett 1(1): 11–23, 2004) by examining relationship lending and hold-up problems in credit markets when borrowers are identical and banks are different. The results show that existing borrowers are informationally captured by good banks and yield profits to them, but new borrowers are unprofitable. In this market, short-term loan contracts and unsecured loans are optimal while loan commitments should not be used. Further, banks and borrowers have long-term relationships. This paper challenges the standard theories on product quality, reputation and experience goods by introducing scenarios in which good and bad banks can retain their existing borrowers. In the standard theories, consumers leave bad producers and search for good ones.

previous article The Real Effects of Universal Banking: Does Access to the Public Debt Market Matter?

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See also Dell’Ariccia et al. (1999), Dell’Ariccia (2001), Berger and Udell (2002, 2006), Hauswald and Marquez (2003, 2006), von Thadden (2004), Dell’Ariccia and Marquez (2004), DeYoung et al. (2004), Bolton and Freixas (2006), Black (2011), Puri et al. (2011, 2017), DeYoung et al. (2015), and Karolyi (2018). Freixas and Rochet (2008), Degryse and Ongena (2008) and Degryse et al. (2009) survey the literature.

In some scenarios of Rajan (1992), long-term loans are optimal.

For empirical evidence, see Agarwal and Hauswald (2010).

For supporting evidence, see Puri et al. (2017).

The existing borrower leaves the initial bad bank with certainty. In this regard the offer of the initial bad bank \( {R}_2^G \) is insignificant. However, the bad bank will attract profitable new borrowers. To hide its true type, the bad bank mimics good initial banks and makes public offer \( {R}_2^G \) to its existing borrower.

Dell’Ariccia et al. (1999), Dell’Ariccia (2001), and Dell’Ariccia and Marquez (2004), for instance, assume this kind of competition in their relationship lending models.

Short-term loans are optimal even if θ₂ < R.

This difference is important in compared with subsection 4.1.

In some model versions of Sharpe (1990), all firms retain the initial lending relationships.

See also Degryse et al. (2009, 115-117) for an extensive survey on the literature.

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Title: Relationship Lending and Switching Costs under Asymmetric Information about Bank Types
Author: J.-P. Niinimäki
Publication date: 05-01-2021
Publisher: Springer US
Published in: Journal of Financial Services Research / Issue 1/2022
Print ISSN: 0920-8550
Electronic ISSN: 1573-0735
DOI: https://doi.org/10.1007/s10693-020-00347-4

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