The real effects of relationship lending

BIS Working Papers No 662
September 2017

Summary

Focus

This paper tests whether longer relationships between banks and their clients have a real impact on firms' behaviour. In particular, we study whether firms with longer banking relationships invested more in physical capital and employed more workers than other firms during the crisis.

Contribution

Building strong relationships with lenders can help firms as banks have an incentive to keep lending to firms they know well, even if they are experiencing temporary difficulties. This paper goes further than the usual focus on whether these longer relationships affect the amount and price of credit by analysing the effects on corporate decisions to invest or employ workers.

We also explore whether the support provided by banking relationships is different when the banking system faces a fundamental or systemic shock. We study this by comparing the effects of relationship lending after the European sovereign debt crisis and after the Lehman default shock. The former directly threatened both the Italian economy and the banking system, while the latter only had an indirect effect on banks, largely through the interbank market.

Findings

Using very detailed data, we find that following Lehman's default, banks offered more favourable lending terms to firms with which they had stronger relationships. Such favourable conditions help firms maintain higher levels of investment and employment. The insulation effects of tighter bank-firm relationships were still present during the European sovereign debt crisis, especially for firms tied to well capitalised banks.

 

Abstract

This paper studies the real consequences of relationship lending on firm activity in Italy following Lehman Brothers' default shock and Europe's sovereign debt crisis. We use a large data set that merges the comprehensive Italian Credit and Firm Registers. We find that following Lehman's default, banks offered more favourable continuation lending terms to firms with which they had stronger relationships. Such favourable conditions enabled firms to maintain higher levels of investment and employment. The insulation effects of tighter bank-firm relationships was still present during the European sovereign debt crisis, especially for firms tied to well capitalised banks.

JEL classification: E44, G21

Keywords: relationship banking, real effects of credit, credit supply