Ph.D., M.A., Economics, Harvard University
B.A., Applied Mathematics, Economics, UC Berkeley
Corporate Finance, Financial Intermediation, Banking, Internal Capital Markets
The Ties That Bind: Bank Relationships and Small Business Lending
Abstract: Banks are a primary source of capital for small, private firms, yet the inner workings of small firms’ bank relationships remain obscure. This paper uses hand-collected, proprietary data from a mid-sized regional bank in the United States to empirically identify the channels that strengthen the relationship between a small business and its bank. In contrast to earlier work that focuses on the role of relationships in alleviating information and incentive problems in lending, I find that the source of value in relationship banking is not limited to enhanced monitoring. I introduce two novel channels of relationship strength that embody an entrepreneur’s non-lending profit appeal for a bank: (1) the depth of cross-selling of non-loan products to the entrepreneur, and (2) the breadth of additional bank business referred through the entrepreneur’s social and professional connections. I show that a borrower’s intensive margin of profit (the depth and profitability of cross-selling) and extensive margin of profit (the quantity and profitability of referrals) lower the cost of
borrowing and generate access to more credit. These effects are additive. A one-standard deviation increase in both cross-selling and referral profits is associated with a 35 basis point reduction in the loan interest rate and a 26 percent increase in the amount of credit available to a firm.