Competition and Relationship Lending: Friends or Foes?

Recent empirical findings by Elsas (2005) and Degryse and Ongena (2007) document a U-shaped effect of market concentration on relationship lending whichvcannot be easily accommodated to the investment and strategic theory of relationship lending. In this paper, we show that this non-monotonicity can be explained by looking at the organisational structure of local credit markets. We provide evidence that marginal increases in interbank competition are detrimental (favourable) to relationship lending in markets where transaction-based loans are a primary (limited) product offered by a vast (tiny) group of large, outside headquartered banks. On the contrary, where relational-based lending technologies are already widely in;use in the market, an increase in competition may drive banks to further cultivate their extensive ties with customers. Finally, we show that when competition comes from functionally distant banks, local intermediaries increase their engagement in relationship lending with local firms, consistent with the flight-to-captivity mechanism introduced by Boot and Thakor (2000) and further discussed by Dell'Ariccia and Marquez (2004) and Hauswald and Marquez (2006).