A Quantitative Theory of Relationship Lending

RePEc Short ID: pfa225
ORCID iD: 0000-0002-3759-2172

Dempsey, Kyle; Faria-e-Castro, Miguel

doi:10.20955/wp.2022.033

Working Paper Revision

A Quantitative Theory of Relationship Lending

Abstract: Borrower-lender relationships tend to be long-lasting, and borrowers switch lenders infrequently. We analyze the aggregate consequences of these facts in a model of heterogeneous banks subject to financial frictions that incorporates lending relationships as a form of customer capital for banks. The model's loan demand system is directly estimated on administrative loan-level data to recover key parameters governing the strength and persistence of relationships. The degree of market power deriving from lending relationships is consistent with a long run reduction in total credit of 4.1% relative to a competitive benchmark. We find that financial and relationship capital are complements, and therefore correlated across banks in equilibrium. Relationship lending amplifies the negative real effects of credit supply shocks, but allows banks to rebuild their buffers faster: in response to an unanticipated 25% drop in bank net worth, loan volume drops 36% more in our baseline model than in a competitive analog with no relationships. In contrast, relationship lending mutes the contractionary real effects of negative credit demand shocks.

Keywords: banking; lending relationships; aggregate dynamics;

JEL Classification: E44; G21;

https://doi.org/10.20955/wp.2022.033