What Kinds of Bank-Client Relationships Matter in Reducing Loan Defaults and Why?

The value of bank relationships is typically thought to arise from repeat lending. However, relationships can be of many kinds, e.g., they could be non-credit based marked by a simple savings or checking account. Further relationships can differ in intensity and depth. What kinds of relationship matters for default behavior? And why? These are important but underexplored questions. We address these questions using a unique, comprehensive dataset of over one million loans from almost 300 banks. We find that retail customers, who have a relationship with their savings bank prior to applying for a loan, default significantly less than customers without prior relationships. We find relationships matter in different forms (transaction accounts, savings accounts, prior loans), in scope (credit and debit cards, credit lines), and depth (relationship length, utilization of credit line, money invested in savings account). Even the simplest forms of relationships such as savings or checking accounts are economically meaningful in reducing defaults. We next assess the channels which lead to lower default rates by accessing detailed data on loan applications, approval and defaults, which allow us to control for endogeneity and selection concerns. Our results suggest that relationships are important in screening but also that relationship banks monitor differently, they react more quickly on signs of trouble reducing their credit limit which eventually leads to lower default rates. Further, we find effects beyond that derived from private information such as reduced consumers’ incentives to default. On the regulatory dimension the demise of many US banks during the Savings and Loans Crisis were attributed to interstate or in-state branching restrictions which resulted in loans being made where banks did not have prior relationships. Our results speak to regulators and loan-makers on the importance of allowing banks to form relationships in the markets in which they lend. Even a simple model where banks ask customers to open savings or checking accounts, observe them and then decide on whether to give loans helps reduce default rates.

Steffen, Sascha, Manju Puri and Jörg Rocholl (2015), What Kinds of Bank-Client Relationships Matter in Reducing Loan Defaults and Why?,