Ebook The number of bank relationships, borrowing costs and bank competition
For more than two decades researchers have been debating on the relationship between the number of bank relationships and the cost of borrowing. On one hand, Diamond’s (1984) classical delegated monitoring theory suggests that exclusive lending relationships minimize loan rates by avoiding duplication of monitoring costs. On the other hand, other authors (e.g. Sharpe (1990) and Rajan (1992)) predict that firms can reduce interest rates by borrowing from several banks.
While international empirical studies have so far found mixed results, the ongoing process of deregulation, globalization and consolidation of the banking industry brings more complexity to the picture: it is still unclear how credit market competition affects the impact of bank relationships on interest rates. This study seeks to make progress in answering these two questions: How does the number of banks that a firm borrows from influence the cost of loans? And what is the impact of the credit market competition on the linkage between the number of banks and the cost of borrowing?
To organize our thoughts, we construct a simple bargaining model in which a firm’s cost of borrowing is the outcome of negotiation between the firm manager and the banker. In our setup the contact between the firm and the bank is frictional and banks have market power. The number of ongoing bank relationships the firm has plays the role of an outside option of funding, and favorably affects the position of the manager in the negotiation. We show that an increase in the number of bank relationships decreases the cost of loans.
The model also shows that a change in the degree of competition can improve or lessen the impact of the number of bank relationships on the cost of loans. The outcome will depend on the degree of complementarity between the number of bank relationships and the tightness of the credit market. In the remainder of the paper, we empirically examine the model’s predictions.
The Portuguese banking sector provides an excellent laboratory for such an exercise. First, Portugal has historically been a bank-based economy. Most external funding of non-financial corporations is provided by banks, with only a very small percentage of the economy raising capital in public markets. Second, during the past decade, which coincides with our dataset, the Portuguese banking sector has experienced remarkable changes due to entries of foreign financial institutions as well as mergers and acquisitions among the banks, providing sufficient variation in the market conditions for our empirical analysis. Third, the Credit Register held by Banco de Portugal provides a comprehensive panel dataset that includes loan information on all loans above 50 euros.
Download
PDF Ebook The number of bank relationships, borrowing costs and bank competition
Posted in :
