Relationships and the Use of Collateral: Evidence from Small Business Finance

Informational asymmetries in financing small business require lenders to continually produce reliable private information about borrower performance. While it is well recognized that information required to monitor short-term working capital loans is quite different from long-term non-recurring loans, yet empirical literature on this issue is in its early stages. This paper shows how the two primary sources of private information - length of bank-borrower relationship and the number of bank-services used - affect collateral requirements for Lines of credit (L/C) loans differently from all other non-recurring loans (non-L/Cs). Our findings confirm previous finding that borrowers with longer relationship are less likely to pledge collateral only for lines of credits (L/Cs). For all non-recurring loans (non-L/Cs) however, the number of financial services used by the borrower (and not the length of the relationship) lowers the incidence of collateral. This new evidence indicates that information generated from banking-relationship may be qualitatively different from information generated from banking-services.