Following the global financial crisis, policy-makers' attention has focused on lending to SMEs, as these were among the most affected when the credit cycle turned. Governments have introduced various measures that may alleviate short-term funding constraints but are unlikely to be a long-term solution. So is there a way to protect entrepreneurs in a more structural way from the cyclicality of credit?
In this Working Paper Ralph De Haas, EBRD;
They differentiate between relationship and transaction lending and find that while there is little difference between these two techniques during good times, it is relationship lending - whereby banks develop long-term relationships with firms to get to know them well - that is the more effective way to lend during cyclical downturns.
The results show that firms that are surrounded by branches of banks that put a lot of emphasis on getting to know their customers, have easier access to credit compared with firms that have to rely on banks that take a more arms' length approach and place less emphasis on borrower due diligence.
These findings suggest that the ability of banks to continue to lend during a crisis, when uncertainty about borrowers' prospects increases, not only depends on banks' own access to funding but also on their ability to adequately screen potential clients.
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