A new study finds that small commercial and industrial loans add value for smaller banking organizations and the “value-enhancing effect” comes primarily from loans with original values of no more than $100,000.
The study looks at the direct effects on banks of long-term bank-firm relationships and finds that this “relationship lending” enhances the value of banking institutions. The study authors state that relationship lending gives a bank an “opportunity to exploit the private information it acquires during the course of relationships,” allows it to sell other products and services to its relationship borrowers, and gives it future opportunities to serve these firms as they grow and expand. The information a bank gains allows it to understand the credit risk it is taking and the bank likely charges a rate lower than an uninformed bank would, thus giving a firm an incentive to stay with a bank and avoid the costs and time it takes to establish a new relationship with another bank. At the same time, banks must also invest in information collection and processing activities as part of this relationship, as small firms are usually harder to monitor and evaluate than larger firms.
Using data from a small business loan survey, the authors find that for commercial and industrial loans, small business lending adds value to banking organizations primarily for small and mid-sized banks and primarily due to original loans of no more than $100,000. But small commercial real estate loans do not add value because they are more transactional than relationship.
