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1/6/2011

Banks & Relationships 1

Banks & Relationships

Chris Lamoureux

Copyright 1996-98 © Lamfin, Inc.

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Relationships in Finance

Calomiris and Ramirez (CR) note:

«Shifts in relationships can be viewed as collectiveattempts by companies and intermediaries tominimize the cost of finance in response tochanges in technology and, most important, in thelegal and regulatory environment .

As we¶ve discussed before, the question of

transaction vs. relationship is really aquestion of what type of relationship.

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What Defines Relationship Banking?

T he raison d¶etre of banks may well be their role inmitigating informational asymmetries. Relationshipbanking is most directly aimed at resolving

problems of asymmetric information. . . .Relationships play a critical role in investment

banking as well and in the activities of nonbank financial intermediaries and private equity and debt markets.

Qualitative Asset Transformation: A bank manages and absorbs risk (e.g., credit and

liquidity risks) by issuing claims on its total assetswith different characteristics from thoseencountered in its loan portfolio.

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Asset Transformation

It is interesting to contrast the nature of asset

transformation performed by commercial banksand investment banks.

Investment banks intercede in the building of a

direct link between the market and the issuer.

Commercial banks internalize this relationship.

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Relationships

Why are bank¶s assets illiquid?

± Information sensitivity

T he access to information is inherently linked to

relationship banking and may point to a

comparative advantage of banks.

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Defining Relationship Banking

± Bank invests in obtaining customer-specific

information, often proprietary in nature; and

± Bank evaluates the profitability of these

investments through multiple interactions with

the same customer over time and/or across

products.

± Distinguish from transaction lending ± arm¶s

length / one at a time.

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A Continuum

A company has a choice of how much of a

relationship should be attached to itscapital acquisition.

Syndicated Loans

Private Debt

Private Equity

Venture Capital

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Relationships Have Many Applications

Companies may derive benefits fromrelationships that apply well beyond capital

acquisition.

Even within the ³banking context´ theseinclude:

± Letters of credit (Including Standby Lines)

± Deposits ± Check clearing

± Cash management

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Securitization

Some may see securitization as the

beginning of the end for banks.

This ignores the credit enhancements

provided by the issuing institution.

Provision of excess collateral Back-Up

³Tranching´ ± putting ability on the line.

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Relationships & Value

± Relationship lending leaves room for

flexibility and discretion in contracts that permits the utilization of subtle

noncontractable information, thereby

facilitating implicit long term contracting.

± Relationship lending may include extensivecovenants that allow for a better control of

potential conflicts of interest.

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Relationships & Value 2

Relationship lending may involve collateral (e.g.,as in asset-based lending) that needs to be

monitored. In fact, the need for such lending and monitoring may make the proximity of arelationship financier essential; otherwise, lending may not occur at all.

Relationship lending may allow the lender to takethe long view ± make a loan that is not profitablein the short term.

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Costs of Relationships

1. Soft Budget Constraint Problem.

2. Hold-up Problem.

The key to understanding these problems is that

when parties enter into a relationship, they will

obviously attempt to position themselves to

have an upper hand in future scenarios.

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Costs of Relationships 2

The soft budget constraint idea is that a bank may find

itself in a position of having so much at stake that it will

take uneconomical steps to keep the borrower afloat.

This does not escape the borrower¶s notice, so that the

borrower does not spend enough resources attempting

to avoid getting into such positions.

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Costs of Relationships 3

The hold-up problem is a local monopoly

problem. At a certain point in arelationship, the bank may be in a more

powerful bargaining position than

competitors.

Credit terms that restrict ex-post

expropriation may solve this problem:

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Solving Hold-up Problem

A long-term line of credit with a termination

clause, which stipulates that the lender may terminate the relationship, but if it

continues it, it must maintain the old

terms, can balance the costs and

benefits of the hold-up problem.

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Competition & Relationships

In the early days of banking, the

Gentleman Banker¶s Code stipulated thatbanks would not compete for each

others¶ business.

Even today, the extent of competitionseems to define the extent of relationship

vs. transaction focus.

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