At such times, managing lending relationships effectively becomes even more important for bank governance, risk, and credit supply.
- At such times, managing lending relationships effectively becomes even more important for bank governance, risk, and credit supply.
- My study presents evidence that continuous lending relationships between bank loan officers and corporate borrowers improve the outcomes of loan renegotiations.
- My main findings are that firms that experience an exogenous interruption in their loan officer relationship are faced with three consequences.
- First, the firms are less likely to renegotiate a loan compared to firms with continuous relationships.
- Second, when loans are renegotiated, firms with interrupted loan officer relationships receive tougher loan terms.
- Firms in the euro area rely to a large extent on loans from credit institutions.
- Such loans account for approximately 30% of euro area firms total liabilities and approximately 85% of their total credit.
- For that reason, the relationship between a loan officer and a firm is expected to affect the issuance and renegotiation of a loan.
- The central finding of the paper is that relationships between loan officers and firms do have a significant positive impact on loan renegotiation.
- In this study firms with interrupted relationships are less likely to renegotiate a loan compared to firms with continuous relationships.
- Lastly, firms alter their capital structure and sources of financing after the relationship with the loan officer is interrupted.
Interruption of bank lending relationships
- Lending relationships between loan officers and borrowers may be interrupted as a consequence of bank mergers and consolidations, interventions by banking supervisors, fintech developments or regular staff rotation policies.
- For example, banks often consolidate their branch networks in response to financial distress, as consolidation reduces operating costs and centralises lending decisions.
- There are two main challenges for accurately estimating the impact of lending relationships on loan renegotiation.
- The reorganisation of the bank gives rise to variation in the length of the relationships between loan officers and firms that is exogenous, i.e.
- A bank unit closure interrupts the relationships between loan officers and firms, because merged accounts are assigned to new loan officers.
- Hard information passes from one loan officer to another during transfers, because the transfer happens within the same bank.
- Therefore any differences observed between the two groups after the consolidation period should be the consequence of interrupted relationships.
Impact on loan renegotiation
- According to my results, firms assigned to a new loan officer were significantly less likely to renegotiate a loan.
- The empirical results show a statistically significant difference in the probability of these firms renegotiating a loan compared to firms with continuous relationships.
- In particular, the results imply a 49% probability of loan renegotiation for firms with an interrupted relationship, compared with a 59% probability for firms with a continuous relationship.
- After the reorganisation (2014-15), the probability of renegotiating a loan is lower for the firms with interrupted relationships.
- Moreover, when loans are renegotiated, the firms with interrupted loan officer relationships receive less beneficial terms and conditions on their renegotiated loans than firms with continuous relationships.
- Firms with interrupted relationships face higher interest rates and significantly shorter maturities, while being required to pledge collateral for an amount 65% higher than firms with continuous relationships.
- The plots below present the evolution of these results graphically.
- The difference in the loan terms appears in the first year after the interruption of the relationship and increases the following year.
Effect of an interruption in the relationship between a loan officer and a firm on loan renegotiation relative to the year before the reorganisation (2013) Source: Papoutsi (2021).
- A change in the capital structure indicates that firms cannot simply substitute lending from other banks without cost when the relationship with one bank is interrupted.
- Firms only partially substitute loans from other banks to make up for reducing the borrowing from the bank where its loan officer relationship was severed.
- First, we do not observe a difference in loan performance in the short run between firms with interrupted relationships and firms with continuous relationships.
- This means that the effects on the terms and conditions of renegotiated loans cannot be explained by firms performing worse economically.
- In contrast, the impact of an interrupted loan officer relationship on loan renegotiation is found to be stronger for firms with good repayment histories, high leverage, and positive growth in earnings.
Impact of interrupted relationships on renegotiated loans’ terms relative to the year before the reorganisation (2013) Effect on interest rate Effect on collateral value Source: Papoutsi (2021).
- This analysis shows that lending relationships have a significant positive effect on corporate loan renegotiation, mitigating the cost of distress for firms.
- Even though the analysis is not directly linked to the COVID-19 crisis, it provides strong evidence that continuous lending relationships help firms during default episodes.
- An uninterrupted relationship between a particular loan officer and a firm helps eliminate frictions that arise when loans are renegotiated.
- For example, in a context of general stress, individual firms could experience interruptions to several different bank loan officer relationships.
- Indeed, while no one is irreplaceable, when it comes to a firms relationship with a bank changing loan officer can be a big deal.
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