Article

Small Business Economics

, Volume 40, Issue 4, pp 899-910

Relationship banking and escalating commitments to bad loans

  • Eugene KangAffiliated withDivision of Strategy, Management & Organization, Nanyang Business School, Nanyang Technological University Email author 
  • , Asghar ZardkoohiAffiliated withDepartment of Management, Texas A&M University
  • , Ramona L. PaetzoldAffiliated withDepartment of Management, Texas A&M University
  • , Donald FraserAffiliated withDepartment of Finance, Texas A&M University

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Abstract

The relationship banking literature suggests that business relationships play an important role in the loan decisions of small banks. We test one aspect of this hypothesis using a cross-sectional panel dataset of small banks located in Texas from 1994 to 2002. Our results suggest that small banks located in smaller counties escalate their commitment to bad loans when compared with those located in larger counties, even after controlling for psychological and social factors that influence escalation tendencies. These results highlight the need for small banks to trade-off the positive benefits of adopting a relationship banking strategy against its unintended negative consequence. We provide some suggestions on how small banks may lessen their escalation tendencies despite adopting a relationship banking strategy. The results of this study also suggest that small and medium-sized enterprises (SMEs) that develop strong relational bonds with small banks may benefit from continued access to credit facilities, especially during periods when they experience financial distress.

Keywords

Relationship banking Escalation of commitment Rural sociology County population

JEL Classifications

C33 D82 G21 M10 L26