Forgive but Not Forget: the Behavior of Relationship Banks when Firms Are in Distress

Larissa Schäfer (Frankfurt School of Finance & Management)

Abstract: Do relationship banks help firms in financial distress? Combining a new survey-based measure of relationship lending with unique credit registry data, I examine the effect of relationship lending on ex-post loan performance. I find that the same firm is more likely to become temporary delinquent on a relationship-based loan relative to a transaction-based loan. Higher delinquencies do not, however, result in more defaults or losses for relationship banks when loans mature. Consistent with theory, relationship banks tolerate temporary bad results, yet extract rents in the long run, that is, they forgive but do not forget. When firms are in distress, relationship banks adjust contract terms and allow drawdowns on credit lines and overdrafts but do not inefficiently roll over loans. Overall, the paper uncovers how relationship banks help distressed firms to bridge liquidity shortages.

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