In getting a good deal on a loan, numbers matter: Lenders look at companies’ financial statements and payback on past loans. Strong financial statements could mean a lower interest rate or better terms for the borrower.
But in the competitive landscape of loan acquisition, it’s not just about crunching numbers. Loan officers and borrowing managers are people, after all, and those who do repeat business build relationships and trust over time. The soft information accumulated in these relationships can reduce the costs of screening and monitoring, and thus reduce the cost of debt, according to new Berkeley Haas research.
“While two companies with the same credit score may appear similar on paper, our research shows that individual lending relationships can reveal important differences between them,” said Omri Even-Tov, assistant professor of accounting at the Haas School of Business. “These relationships foster trust and reduce information gaps, allowing lenders to gain valuable soft information about a borrower’s sense of responsibility and overall creditworthiness.”
Even-Tov’s forthcoming paper in the Review of Accounting Studies—coauthored by Xinlei Li of the Hong Kong University of Science and Technology, Hui Wang of the Renmin University of China, and Christopher Williams of the University of Michigan—shows that established relationships between a loan officer and a borrowing manager not only increase the likelihood of a loan, but tend to make the conditions of that loan better for the borrower without increasing risk for the lender.
These results, the researchers suggest, are increasingly important as technological innovation means fewer personal relationships in banking—and beyond.
Even-Tov and his colleagues examined a sample of loans from between 1996 and 2016. They manually collected the signatures on these loans to determine the names of two key actors who are typically engaged in contracting negotiations and interact extensively. This laborious process allowed them to create a dataset comprising nearly 4,000 loans with 2,800 unique borrowing managers and 2,100 unique loan offices. The vast majority of these loans were one-off interactions, but some of them were conducted by the same loan officer and borrowing manager two or more times.
Comparing these groups, the researchers found that established relationships between lenders and borrowers proved favorable for both parties. For the borrowers, they led to better interest rates. For the lenders, they allowed for better screening and monitoring as evidenced by fewer rating downgrades.
The cost of turnover
They also found that when a borrowing manager and loan officer left their jobs, the two firms were roughly 70% less likely to engage in business together. These results were especially pronounced among smaller institutions, and with loan officers who manage fewer transactions, as these two groups rely more heavily on soft information accumulated in their relationships.
“This really quantifies a lot of anecdotal evidence about the importance of relationships, and it also sheds light on an underappreciated cost of turnover,” Even-Tov said. When an employee leaves a company, it’s a loss not only of their knowledge and skills, but their relationships, too. If a company loses its CFO, it has not only lost that distinct set of talents, but possibly the chance of getter better deals on loans. “Companies need to factor in these less-tangible assets of their employees.”
Decline in professional relationships
Even-Tov highlighted two related implications raised by this paper: New technological tools are driving a decline in professional relationships, and this is happening in industries beyond banking. He gave the auditing industry as an example. Auditors in previous years would be embedded in clients’ offices. They got to know the companies they were auditing, and the people who worked there. Today, a great deal of auditing is done remotely, or even automatically. The same is true for consulting, real estate, venture capital, and private equity.
“We need to think about what we lose when technologies allow us to bypass the need for interaction between individuals,” Even-Tov said. “There are advantages to doing this work more quickly or from a distance, of course. But these changes also introduce costs, and this work makes some of those costs clear.”
Read the paper:
The Importance of Individual-Pair Lending Relationships
By Omri Even-Tov, Xinlei Li, Hui Wang, and Christopher Williams
Review of Accounting Studies (forthcoming)