Bank Lending to Companies
Wednesday, 5 February 2020 12:24
Contrast is with 'market-based' finance, i.e. bond markets:
- Bonds can be traded
- Many investors, mainly non-bank
- Normally no relationship with borrower
- Prospectus required for public issue
- Rating expected
Bank loan:
- Customised contract, not designed to be traded
- Product is a loan facility: drawdown at discretion of borrower
- Ongoing relationship between bank and borrower
Advantages of a bond market
- Normally cheaper for large amounts (min $100m)
- Market should price assets or set interest rates more efficiently than a bank,
given same info
Advantages and Disadvantages to Lending Relationships
Boot, J of Fin'l Intermediation 9, 2000
Advantages of lending relationship
- Relationship banking means provision of services in which:
○ Bank invests in obtaining private information about customer
○ Bank has multiple interactions with customer
- Concept of bank as a delegated monitor (Diamon, 1984)
- Fundamental reason bank loans are not traded is that only the lending bank
has the information to value a given loan
- Relationships are not restricted to commercial banking. Investment banking,
private equity, private placements of debt, and venture capital all involve
relationships
1. Cheaper, easier, more discreet to divulge info to bank on a private basis than
to market on public basis
2. Renegotiation is easier with a loan than bond. One-to-one, and based on
better info and goodwill. Facilities agreement of detailed covenants. Ease of
negotiation especially NB in case of bad debts
, 1. Cheaper, easier, more discreet to divulge info to bank on a private basis than
to market on public basis
2. Renegotiation is easier with a loan than bond. One-to-one, and based on
better info and goodwill. Facilities agreement of detailed covenants. Ease of
negotiation especially NB in case of bad debts
3. Monitoring of collateral is easier
4. May be possible to subsidise young companies or projects at an early stage,
and recoup losses later
5. Monitoring by bank can reduce agency problems in the company (not
stressed by Boot)
The ultimate benefit of the above is that funds are provided to borrowers more
efficiently
Disadvantages of lending relationship
1. 'Soft-budget constraint'. In some situations, bank will lend more to prevent
liquidation. Borrower knows this and does less to avoid a bad outcome.
2. Seniority of loan helps make a threat of calling the loan more credible.
Reason is that value of a senior loan is less sensitive to value of borrower
(which could fall if loan is called)
3. 'Hold-up problem': threat of overcharging a 'trapped' borrower. Could
borrow from more than one bank, but then advantages of relationship are
reduced.
Boot's conclusion
Relationship banking does add value, but the value-added may be eroding
Effects of competition
- Implies borrowers shop around more
○ Reduces value of bank's private info, and so reduces incentive to
acquire this info. Banks less willing to subsidise young firms
- However, Boot believes the lending relationship enables the lending bank to
be more unique
Are banks and bond markets converging?
- Syndicated loans have become common and are not one-to-one
- Loan participations can be traded
- 'Securitisation' of loan portfolios undermines incentive of originating bank to
monitor. So does ability to insure against default risk
- On the bond side, corporate bond markets are developing slowly. There are
more specialist investors in debt. More private placements of bonds (similar
to bank loans in some ways)
Wednesday, 5 February 2020 12:24
Contrast is with 'market-based' finance, i.e. bond markets:
- Bonds can be traded
- Many investors, mainly non-bank
- Normally no relationship with borrower
- Prospectus required for public issue
- Rating expected
Bank loan:
- Customised contract, not designed to be traded
- Product is a loan facility: drawdown at discretion of borrower
- Ongoing relationship between bank and borrower
Advantages of a bond market
- Normally cheaper for large amounts (min $100m)
- Market should price assets or set interest rates more efficiently than a bank,
given same info
Advantages and Disadvantages to Lending Relationships
Boot, J of Fin'l Intermediation 9, 2000
Advantages of lending relationship
- Relationship banking means provision of services in which:
○ Bank invests in obtaining private information about customer
○ Bank has multiple interactions with customer
- Concept of bank as a delegated monitor (Diamon, 1984)
- Fundamental reason bank loans are not traded is that only the lending bank
has the information to value a given loan
- Relationships are not restricted to commercial banking. Investment banking,
private equity, private placements of debt, and venture capital all involve
relationships
1. Cheaper, easier, more discreet to divulge info to bank on a private basis than
to market on public basis
2. Renegotiation is easier with a loan than bond. One-to-one, and based on
better info and goodwill. Facilities agreement of detailed covenants. Ease of
negotiation especially NB in case of bad debts
, 1. Cheaper, easier, more discreet to divulge info to bank on a private basis than
to market on public basis
2. Renegotiation is easier with a loan than bond. One-to-one, and based on
better info and goodwill. Facilities agreement of detailed covenants. Ease of
negotiation especially NB in case of bad debts
3. Monitoring of collateral is easier
4. May be possible to subsidise young companies or projects at an early stage,
and recoup losses later
5. Monitoring by bank can reduce agency problems in the company (not
stressed by Boot)
The ultimate benefit of the above is that funds are provided to borrowers more
efficiently
Disadvantages of lending relationship
1. 'Soft-budget constraint'. In some situations, bank will lend more to prevent
liquidation. Borrower knows this and does less to avoid a bad outcome.
2. Seniority of loan helps make a threat of calling the loan more credible.
Reason is that value of a senior loan is less sensitive to value of borrower
(which could fall if loan is called)
3. 'Hold-up problem': threat of overcharging a 'trapped' borrower. Could
borrow from more than one bank, but then advantages of relationship are
reduced.
Boot's conclusion
Relationship banking does add value, but the value-added may be eroding
Effects of competition
- Implies borrowers shop around more
○ Reduces value of bank's private info, and so reduces incentive to
acquire this info. Banks less willing to subsidise young firms
- However, Boot believes the lending relationship enables the lending bank to
be more unique
Are banks and bond markets converging?
- Syndicated loans have become common and are not one-to-one
- Loan participations can be traded
- 'Securitisation' of loan portfolios undermines incentive of originating bank to
monitor. So does ability to insure against default risk
- On the bond side, corporate bond markets are developing slowly. There are
more specialist investors in debt. More private placements of bonds (similar
to bank loans in some ways)
