A Multistage Model of Loans and the Role of Relationships

Sugato Chakravarty · Tansel Yilmazer

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Banking stability, regulation, efficiency Corporate Finance and Governance Working Capital and Financial Performance

Abstract

We develop a multistage model of the loan granting process to understand the contradictory findings of the existing literature on bank‐borrower relationships, credit availability, and loan rates. Upon estimating our model with the 1993, 1998, and 2003 versions of the Survey of Small Business Finances data set, we find that relationships matter in a borrower's decision whether to apply for a loan and in the loan approval/rejection decision by the financial institution. However, the effect of relationships on loan rates depends on the prevailing economic climate. While firms with preexisting relationships obtain credit at lower rates during periods of economic expansion, loan rates are not negatively correlated with preexisting relationships during periods of economic recession.

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References

1983Limited-dependent and qualitative variables in econometrics 1981Credit Rationing in Markets with Imperfect Information 1994The Benefits of Lending Relationships: Evidence from Small Business Data 1992Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt 1998The economics of small business finance: The roles of private equity and debt markets in the financial growth cycle 1995Relationship Lending and Lines of Credit in Small Firm Finance 1995The Effect of Credit Market Competition on Lending Relationships 1991Monitoring and Reputation: The Choice between Bank Loans and Directly Placed Debt

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