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United States Small Business Administration
Office of Advocacy
RS 173
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Purpose
Small business owners regularly cite inadequate access to credit
as one of the most important problems they face. One factor that
discourages lending is the lack of information on the creditworthiness
of small firms. Although information problems exist in all credit
transactions, they are particularly acute in the small business
finance market. The cost to a bank for searching out credit information
on an individual small business may be large in comparison with
the loan size, thus discouraging the bank from offering credit.
The lack of published and standardized financial information on
small businesses increases the importance of informal information,
such as that which is gathered through personal interaction with
the borrowers or third parties. In the case of small businesses
there is relatively little third-party information available,
so the relationship between the borrower and the lender is exceedingly
important.
This research project, part of a Ph.D dissertation, tests the
hypothesis that personal relationships between borrowers and lenders
affect loan terms and conditions in the U.S. small business credit
market.
Scope and Methodology
A theoretical model was developed to describe the role played
by relationships in the credit market. The dissertation suggests
that the relationship that exists between the borrower and lender
is an important factor in the loan quality that can affect the
interest rate charged by lenders. A relationship provides frequent
opportunities for the lender to monitor and directly communicate
with the borrower, thus reducing the transaction costs. Moreover,
repeated interaction between the lender and the borrower creates
a "reputation" for the borrower -- his or her good name
serves as a form of collateral securing the loan.
The theoretical model provides a framework for empirical tests.
First, it suggests that a borrowerlender relationship should
reduce the interest rate charged in a competitive credit market,
other things being equal. Second, it suggests that the distance
separating a bank and a given client may affect loan interest
rates. Third, the model specifies that different client characteristics,
such as equity investment, may affect the interest rate on credit
as well as the size of the loan.
Information available in the National Survey of Small Business
Finances (NSSBF) was used to empirically test the interest rate
model. The NSSBF, commissioned jointly by the U.S. Small Business
Administration and the Board of Governors of the Federal Reserve
System in 1988, provides data on approximately 3,400 enterprises.
Of particular importance for this study, firms were asked numerous
questions regarding the nature of their relationships with up
to six financial institutions. Direct evidence of the importance
of relationships was solicited, including information on the distance
between the business and financial institution, the method of
communication (in person or by telephone, etc.), and the owners'
reasons for choosing their financial institutions.
The variables used to measure the closeness of the borrower-lender
relationship were grouped into five categories for a regression
analysis: (1) loan characteristics; (2) financial characteristics
of the small firm borrower; (3) relevant nonfinancial characteristics
of the small firm; (4) characteristics of the borrowerlender
relationship; and (5) information on the macroeconomic environment.
Highlights
Ordering Information
The complete report is available from:
National Technical Information Service
U.S. Department of Commerce
5285 Port Royal Road
Springfield, VA 22161
(703) 487-4650
(703) 487-4639 (TDD)
Order number: PB96 195433
Price codes: A03/$19.50; A01/$10.00 Microf.
*Last Modified 6-11-01