Information acquisition in SME's relationship lending and the cost of loans

This study analyzes the effect of the reputation SMEs get in a relationship lending on the cost of next loans. A unique dataset of 734 Spanish SMEs' relationship lending provides information on a loan-by-loan basis about the ex post previous loan performance, which measures reputation. No prior empirical research differentiates the cost of loans following a defaulted loan from the costs of those following a successfully repaid loan. Results show that lenders obtain information about borrowers' risk-level during relationship lending and use this information. Loans granted after a successful one pledge significantly lower collateral and interest rate than loans granted after a defaulted one. However, the pledged collateral is stronger in the second loan not only following a defaulted loan but also following a successfully repaid one. This result is consistent with the credit screening mechanism, in which good borrowers differentiate themselves from bad ones by pledging high collateral to get lower interest rates.