EFFECT OF LENDER FRAGILITY ON BANKING RELATIONSHIPS

Abstract

Many academic studies on financial intermediation have focused on the determinants and consequences of bank fragility. In light of the recent financial crises, this paper extends this literature further by examining the impact of lender fragility on lender selection and banking relationships. Other endogenous effects such as lender market power and borrower fragility are also explored. Using a database of individual loan facilities, I find that borrowers are less likely to select lenders with a high probability of default. However, a prior relationship can mitigate this “lender fragility”’ effect. Finally, in times of increasing systemic-wide economic fragility, loan relationships can generate economic value for both the lender and borrower by giving both a selection advantage over other parties. This leads to the idea of “borrower runs” and a rising need to protect these fragile lenders.