Does it matter if banks offer one-shot lending or if they are concerned with establishing long-term relationships? It does, according to a study conducted by BI Norwegian Business School.
Traditionally, local banks have been concerned with establishing long-term relationships with borrowers. Loyal customers have been considered “golden” customers. Local banks know their customers well, and have been able to be flexible should a customer need extra credit during a difficult period.
In recent years, we have seen major changes in the banking sector.
Large banks have expanded across regions and country boundaries, and often offer one-shot lending. They focus less on repeat lending to the same customer.
A changing sector
Non-bank lenders have also entered the lending market. Typically, the new players also offer one-shot lending. They are also less concerned with developing long-term customer relationships.
In addition to this structural change, the financial crisis has contributed to derail many long-term relationships between banks and borrowers. Borrowers have been obliged to sell off mortgaged property to repay loans to banks hardest hit by the financial crisis. The exception is banks with a solid balance sheet.
Does it matter if banks are concerned with developing long-term relationships or if they offer one-shot lending?
"Yes, it does,” says Bogdan Stacescu, Associate Professor of finance at BI Norwegian Business School, based on a study of how banks assess loan applications.
Collateral or credit check?
Together with researcher Artashes Karapetyan, Bogdan Stacescu has conducted a study of whether different lending practices influence the various methods of assessing potential borrowers.
When banks assess loan applications, they can either conduct a thorough credit appraisal of the borrower or ask for collateral as security for the loan (often in the form of a building or other property).
Both methods are costly.
A credit appraisal requires a thorough and time-consuming screening of the loan application and gathering of information about the applicant's creditworthiness.
If the bank requires collateral, it risks suddenly having to take possession of a house (or other mortgaged property) should the borrower default on his loan. In a crisis, this may reinforce a potential economic downturn through compulsory sale of several properties.
Long-term relationships are a good idea
The two financial researchers have developed a model to determine whether or not it matters if banks are concerned with repeat customers.
The results were published in a research article presented at the annual FIBE Conference held at the Norwegian School of Economics in Bergen in January 2016.
Stacescu and Karapetyan find that banks that assess a loan application from one of the bank's previous borrowers prefer to conduct a credit appraisal instead of asking for collateral as security.
If there are prospects of repeated lending, it reduces the likelihood of the bank requiring collateral, also when it assesses a given borrower's first loan application.
"The study shows that long-term relationships between banks and borrowers are a good idea. The use of credit appraisal instead of collateral also generates value for society,” Bogda Stacescu points out.
Received research award
The BI researcher was awarded the 2016 FIBE award (Publisher's prize) for the best research contribution at the 2016 FIBE Conference. The competition is open to researchers under the age of 40. The prize consists of NOK 20 000.
"This is a significant recognition for me. It was also high time that the award was granted to the BI Norwegian Business School finance community," says Bogdan Stacescu.
Artashes Karapetyan and Bogdan Stacescu: "Collateral and Informed Screening During Banking Relationships". Research article presented at the 2016 FIBE Conference at the Norwegian School of Economics in Bergen.