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 lender switching is infrequent. What are the aggregate consequences of these facts? We address this question in a model of heterogeneous banks subject to financial frictions. We incorporate lending relationships using loan portfolio adjustment costs for borrowers and accumulation of "relationship capital" for lenders. The model's implied loan demand system is directly estimated on administrative loan-level micro data to recover the key novel parameters governing the strength and persistence of lending relationships. We find that financial and relationship capital are complements, and so banks constrained with respect to one tend to be constrained with respect to the other. Relationship lending generates endogenous persistence in the economy's response to financial crises, with recoveries becoming more sluggish, and it also affects the interplay between monetary policy and financial stability.

Keywords: banks; customer capital; relationship lending; interest rates; financial crises;

JEL Classification: E4; G2;

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