Relationship banking

In Relationship Banking (also: solid customer-bank relationship ) is, to a connection between a bank and a customer, which goes beyond the execution of simple, anonymous financial transactions. The bank gains (confidential) information about the borrower. The profitability is judged from repeated interaction. This includes interactions over a longer period of time as well as with regard to the requested products and services.

A house bank relationship is also characterized by the dominant financing share of the committed bank. In this way, the house bank also bears “special responsibility” in crisis situations for the borrower.

Definition by boat (2000)

Source: Boot, AWA “Relationship Banking: What do we know” Journal of Financial Intermediation, Vol. 9 (2000), pp. 7-25.

According to Boot (2000), relationship banking is the provision of financial services by a financial intermediary. The financial intermediary tries to do this

Receive specific, relevant and private information about the customer
evaluate the profitability of investments through multiple interactions with the customer

Theoretical Analysis of Relationship Banking: The Petersen and Rajan Model

Source: Petersen / Rajan, The effect of credit market competition on lending relationships, in: the quarterly journal of economics, pp. 407–443, 1995 (esp. Pp. 407–414)

starting point

Petersen and Rajan consider solid customer-bank relationships.

Mixed calculation of time and products

In the case of a long-term house bank relationship, it is possible for the lender to make a mixed calculation over time and over products when determining the conditions.

Profit from avoiding adverse effects

In this way, problems of asymmetric information ( adverse selection ) and moral hazard (increasing project risk) can be reduced. The precondition of their model for the authorization of a customer-bank relationship is the monopoly of the lender.

Initially, interest rates are kept too low relative to the average borrower quality. This attracts good risks as well as bad. So there are no adverse effects.

Later, the interest rates are increased accordingly (greater than the average borrower quality) to compensate for the loss in the first period. This is successful because, because of the private information that the bank now has, only good borrowers are financed.

Assumptions

Types of borrowers

There are risk-neutral good and bad borrowers:

Good borrowers choose a project that can be either safe or risky to begin with.
Bad borrowers are characterized by the fact that they choose the project that is certain to fail after a period .

Successful companies can therefore undertake a second project.

In the initial period, the bank does not know the individual quality of the borrowers, only the proportion of ${\ displaystyle \ theta}$ good borrowers ( ex ante information asymmetry ). This changes after a period (t = 1), then the information distribution is symmetrical again; the bank knows the quality of the borrowers. During this time, the bank gains extensive information from the credit relationship.

Profit development

The following assumptions are also made regarding profit and loss:

The sequence of safe projects generates a profit:

{\ displaystyle y_ {2} ^ {S} + y_ {1} ^ {S} -I_ {1} ^ {S} -I_ {0}> 0}

The sequence of risky projects generates a loss in the expected value.

{\ displaystyle p (y_ {2} ^ {R} + y_ {1} ^ {R} -I_ {1} ^ {R}) - I_ {0} <0}

The safe projects in t = 1 have equal expected repayments and expected investments. The repayment is greater than the investment.

{\ displaystyle py_ {2} ^ {R} = y_ {2} ^ {S}> pI_ {1} ^ {R} = I_ {1} ^ {S}}

The returns are not sufficient to finance the follow-up project: the loan requirement is

{\ displaystyle I_ {1} ^ {R} \ geq I_ {1} ^ {S}> y_ {1} ^ {R}> y_ {1} ^ {S}}

running time

In addition, loans are only granted for a period

Lending in and

{\ displaystyle t = 0}

{\ displaystyle t = 1}

Reason for single-period lending: no loan collateral , therefore only selection based on the loan term .

At the beginning, the bank only knows the general composition of a population of borrowers, but not the quality of an individual. This changes after the first period.

The capital market interest rate is 0% .

Market power

Critical assumption of monopoly position. Reasons for market power are:

Benefit from a longer relationship with the customer
Information advantage

In t = 1 the bank has market power or a monopoly accordingly

{\ displaystyle {\ frac {y_ {2} ^ {S}} {I_ {1} ^ {S}}}> M \ geq 1}

.

mechanism

Initially, interest rates are kept low relative to the average borrower quality. In this way, adverse effects and information problems are mitigated. The bank can make losses as a result, there is a kind of subsidization.

A good borrower chooses the safe project if his expected utility is greater than that of the risky project: ${\ displaystyle t = 0}$

{\ displaystyle \ max (y_ {2} ^ {S} -M (I_ {1} ^ {S} - (y_ {1} ^ {S} -R_ {1}))), 0) \ geq \ max ( p (y_ {2} ^ {R} -M (I_ {1} ^ {R} - (y_ {1} ^ {R} -R_ {1}))), 0)}

{\ displaystyle R_ {1} \ leq {\ frac {y_ {1} ^ {S} -py_ {1} ^ {R}} {1-p}}}

The bank issues a loan in case ${\ displaystyle t = 0}$

the good borrower chooses the safe project in ${\ displaystyle t = 0}$
the expected repayment at the given capital market interest rate of zero corresponds to the capital provided

{\ displaystyle \ theta R_ {1} -I_ {0} + \ theta (M [I_ {1} ^ {S} - (y_ {1} ^ {S} -R_ {1})] - [I_ {1 } ^ {S} - ((y_ {1} ^ {S} -R_ {1})] \ geq 0}

{\ displaystyle R_ {1} \ geq I_ {0} / (\ theta M) - (M-1) / M (I_ {1} ^ {S} -y_ {1} ^ {S})}

Using the two inequalities for , a critical borrower quality can be calculated at which the bank still grants a loan. ${\ displaystyle R_ {1}}$ ${\ displaystyle \ theta ^ {*} (M)}$

After the borrower quality is known after a period, the bank only grants credit to the good borrowers. Due to its market power, it can also enforce a higher repayment in and thus compensate for the lower repayment . In relation to the average borrower quality, the interest rates are then too high. ${\ displaystyle t = 1}$ ${\ displaystyle t = 2}$ ${\ displaystyle t = 1}$

Results

As market power increases, lower-quality borrowers also receive credit (at least for a period).

The low repayment offered in (compared to a competitive situation among banks) avoids adverse selection and risk increases by the borrower. ${\ displaystyle t = 0}$ ${\ displaystyle R_ {1}}$

In the bank may have a higher repayment with low competition call (from the good capital holders) and thus the lower repayment (of the good and bad capital holders) after the first period against finance. ${\ displaystyle t = 1}$ ${\ displaystyle R_ {2}}$ ${\ displaystyle R_ {1}}$ ${\ displaystyle t = 1}$

The adjustment options in multi-period credit relationships enable efficiency gains in comparison to unchangeable contracts.

discussion

Market power can result both from restricted competition and from an information advantage. The information advantage arises from exclusivity d. H. Concentration on a specific customer group, the duration of the customer relationship, the physical proximity or the simultaneous use of other non-credit banking products.

Information spillover causes banks to lose market power, as their competitors get access to the information without having paid for it.

There has been empirical evidence of SME funding in the United States.

Boot and Thakor come to an opposing connection between market power and relationship banking.

Web links

Individual evidence

↑ Ongena, Smith (2000): Bank Relationships: A Review , in Performance of Financial Institutions: efficiency, innovation, regulation , 1st publ. Cambridge University Press, 2000, pp. 221-258.
↑ Petersen, Rajan (1995): The Effect of Credit Market Competition on Lending Relationships, Quarterly Journal of Economics, 110, pp. 406-443.
↑ boat, Thakor (2000): Can Relationship Banking Survive Competition ?, Journal of Finance, 55, pp 679-713.

[1] Ongena, Smith (2000): Bank Relationships: A Review , in Performance of Financial Institutions: efficiency, innovation, regulation , 1st publ. Cambridge University Press, 2000, pp. 221-258.

[2] Petersen, Rajan (1995): The Effect of Credit Market Competition on Lending Relationships, Quarterly Journal of Economics, 110, pp. 406-443.

[3] t, Thakor (2000): Can Relationship Banking Survive Competition ?, Journal of Finance, 55, pp 679-713.