The Roles of Relationship Lending and Utilization of Soft Information on Bank Performance in Competitive Local Markets

In this study, we examined the influence of soft information used in relationship lending on banks' financial profitability and credit risk, especially focusing on inter-bank competition. This paper is the first one to use an inter-bank competition perspective to analyze what kind of soft information is important and should be collected by banks to raise their profitability and improve their judgment of credit risk. In this paper, soft information factors are determined by three principal factors: organizational systems, networks or alliances/partnerships, and business / management leadership, based on a survey of regional and cooperative banks in Japan. Results from 310 banks shows on average that the use of soft information leads to high profitability and low bad loan ratios, but differ across those three soft information factors. Two of the factors were found to be significant: networks or alliances/partnerships and business/management leadership had a positive effect on financial profitability. These results were especially dramatic with competitive markets. In conclusion, the utilization of soft information by banks results in increased profitability. When soft information is used in a competitive local market; there is a significant reduction in the loss of profit. In addition, we reported on the influence of inter-bank competition on the level of use of soft information. Our results show that the banks in relatively competitive local market are using the information on networks or alliances/partnerships and business/ management leadership more positively.