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Relationship lending and SME financing in the continental European bank-based system

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Abstract

This paper analyzes the relationship between banks and SMEs in the continental European bank-based system. We find that SMEs with longer bank relationships have enhanced access to loans, but at the same time they bear a higher cost for their debt. We also find that firms maintaining two bank relationships get the cheapest debt, which establishes a limit for the degree of concentration of bank relationships. Our results also show that the existence of trust between firm and bank improves access to financing and reduces the borrowing costs, whereas it increases the likelihood that guarantees will have to be provided. As a consequence, it seems that a relationship based on trust is a better strategy to improve SMEs’ access to finance than the establishment of longer or more concentrated relationships.

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Notes

  1. According to Mayer (1994), in the Anglo–Saxon model the resources are channeled fundamentally via the financial markets, whereas in the Continental model most resources are channeled via financial intermediaries, basically the banks. See Appendix 1 for a review of the most important results on the effect of relationship lending on SMEs’ financing.

  2. The Economic Observatory of SMEs of the region of Murcia (Observatorio Económico de la Región de Murcia) is a tool developed by the public development agency Instituto de Fomento of the region of Murcia to analyze the economic and business reality of SMEs, in order to aid decision-making on the part of the regional administration.

  3. The survey was conducted in the first half of 2001. The size of the sample was set to ensure that the margin of maximum error for the estimate of a proportion (relative frequency of answer in a specific item of a question) was less than 0.05 points with a level of confidence of 95%.

  4. The database SABI is compiled by the firm Bureau Van Dijk using the annual accounts filed in company registries by Spanish and Portuguese firms. We included only companies where the SABI database had accounting data available for the years 1999 and 2000 in order to obtain the average values of the balance sheet data.

  5. The variables included in this and the following models are described in Table 1.

  6. The logarithmic transformation of this and other variables—Concentration, Size, and Age—is very common in the bank relationship literature, since it is a monotonic transformation that does not alter the characteristics of the initial variable, and at the same time allows us to test whether the effect of the variable declines (Petersen and Rajan 1994). Regarding the variable length, the censoring problem analyzed by Ongena and Smith (2001) does not apply because there is a big difference between their paper and ours. They study the determining factors of the whole length of the relationship, so they need to know not only the beginning, but also the end of the relationship. We, on the other hand, are interested in the length of the relationship up to one specific date, regardless of when it will finish.

  7. The financing charges do not include either variations in the provisions of the financial investment or negative foreign currency adjustments.

  8. The SABI database does not provide disaggregated data on the various sources of external financing used by firms. This prevents us from differentiating between resources coming from banks and those granted by suppliers.

  9. Following Kim et al. (1998), the economic impact of statistically significant explanatory variables is measured as the percentage of change (over the mean value) in the dependent variable due to a one standard deviation change in the explanatory variable, all other things being equal.

  10. According to Rheinbaben and Ruckes (2004), a firm’s optimal bank financing policy is characterized not only by the number of banks, but also by the amount of confidential information given to the creditor. Highly rated companies tend to deal with many creditors and disclose little private information, whereas firms whose initial credit rating is low must disclose a substantial amount of private information in order to reduce creditors’ uncertainty about their quality. They can reduce the severity of information leakage by restricting themselves to a small number of creditors.

  11. Besides the competition, working with two creditors can be a wise decision because it may reduce the liquidity risk—the risk of early termination of profitable projects. As Detragiache et al. (2000) show, when the firm’s adverse selection problem is important, which is the case for the SMEs in our sample, increasing the number of bank relationships increases the chance of finding one creditor ready to grant the financing, and hence of avoiding the early liquidation of the project.

  12. Firms that borrow from a smaller number of lenders might also obtain their resources paying a lower risk premium due to their higher quality (Cole 1998; Farinha and Santos 2002). To assess whether firms’ quality differs according to their borrowing structure, in Appendix 2 we present the mean values of important indicators for groups of firms with one, two, or more than two lenders. We also provide the p-value of ANOVA models that test for significant differences of the means across the three groups. The results show that there are no differences in terms of working capital, cash flow generation, profitability, and degree of capitalization between firms with different levels of borrowing concentration. Thus, they do not support the hypothesis that higher quality firms tend to maintain exclusive or highly concentrated bank relationships.

  13. It is also consistent with the model developed by Baas and Schrooten (2006).

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Acknowledgement

Financial support from Fundación CajaMurcia is gratefully acknowledged.

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Authors and Affiliations

  1. Technical University of Cartagena, Cartagena, Spain

    Ginés Hernández-Cánovas

  2. University of Murcia, Murcia, Spain

    Pedro Martínez-Solano

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  1. Ginés Hernández-Cánovas
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  2. Pedro Martínez-Solano
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Correspondence to Pedro Martínez-Solano.

Appendixes

Appendixes

Appendix 1 Relationship lending empirical evidence
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Appendix 2 Firm characteristics and borrowing concentration
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Hernández-Cánovas, G., Martínez-Solano, P. Relationship lending and SME financing in the continental European bank-based system. Small Bus Econ 34, 465–482 (2010). https://doi.org/10.1007/s11187-008-9129-7

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