Determinants of Bank Involvement with SMEs (eBook)

Preface 6
Contents 8
Abstract 11
Part I Introduction 13
1 Bank Involvement with SMEs: Introduction 14
1.1 Background and Overview 14
1.2 Financing Options for SMEs 17
1.3 Rationale for Bank Finance for SMEs 19
References 19
Part II Theoretical Framework 22
2 Theoretical Views on Money Creation and Credit Rationing 23
2.1 Loanable Funds Theory Versus Post-Keynesian Endogenous Money Theory 23
2.2 Information Asymmetry and Credit Rationing 25
2.2.1 The New-Keynesian Theory---The Stiglitz and Weiss (S-W) Model 25
2.2.2 The Post-Keynesian Theory of Credit Rationing 26
References 27
3 A Simplified Model of Adverse Selection in Loan Markets 29
3.1 Solution of the Model Under Perfect Information 30
3.1.1 Intuitions 30
3.2 Solution of the Model Under Asymmetric Information 31
3.3 Tools to Help Solve Adverse Selection Problems 32
3.4 Tools to Help Solve Moral Hazard Problems 33
3.5 Credit Rationing and the Use of Loan Commitments 35
References 35
Part III Determinants of Credit Availabilityto SMEs 36
4 Demand-Side Factors Affecting Bank Lending to SMEs 37
4.1 Firm Characteristics 37
4.1.1 Firm Size 37
4.1.2 Firm's Age/Transparency 38
4.1.3 Firm Profitability/Financial Performance 38
4.1.4 Financial Stability (Leverage and Liquidity) 39
4.1.5 Firm's Organisational Form 40
4.1.6 Nature of Business of Firm's Industrial Sector 40
4.1.7 Firm's Credit Rating 41
4.2 Owner Characteristics 41
4.2.1 Owner/Entrepreneur's Credit Rating 41
4.2.2 Owners' Educational Attainment 42
4.2.3 Owners' Business Experience 42
4.2.4 Owner's Equity Stake/Contribution 42
4.2.5 Owner's Personal Wealth 43
4.2.6 Owner's Physical/Social Characteristics (e.g. Age, Gender, Race, and Nationality) 43
4.3 Firm-Lender Relationship Characteristics 43
4.3.1 Deposit Relationship 44
4.3.2 Loan Relationship 44
4.3.3 Financial Management Relationship 44
4.3.4 The Length and Exclusivity of Relationship 45
4.3.5 Distance and Mode of Interaction 45
4.3.6 Effects of Relationships on the Availability of Credit 46
4.4 Demand Side Market Failures 46
4.4.1 Availability of Marketable Collateral 46
4.4.2 Strength of Borrowers' Balance Sheet 47
4.4.3 Information Market Failures 47
4.4.4 Business Confidence 48
4.4.5 Poor Quality of Projects 48
4.4.6 Inability to Exploit Existing Opportunities 48
References 49
5 Supply-Side Factors Affecting Bank Lending to SMEs 52
5.1 Risk and Cost Factors 52
5.1.1 Cost of Funds 52
5.1.2 Informational Asymmetries 52
5.1.3 Lenders' Risk Appetite 53
5.1.4 Transaction Costs 54
5.2 Financial Institution and Market Structure 54
5.2.1 Bank Size and Organizational Structure 54
5.2.2 Ownership Structure 55
5.2.3 Effect of Bank Consolidation 56
5.2.4 Effect of Bank Market Structure and Competition 57
5.2.5 The Profitability Incentive 58
5.3 Lending Technology 59
5.3.1 Relationship Lending 60
5.3.1.1 Benefits of Relationship Lending 60
5.3.1.2 Costs of Relationship Lending 62
5.3.2 Small Business Credit Scoring (SBCS) 64
5.3.2.1 Advantages of Credit Scoring 65
5.3.2.2 Pitfalls of Credit Scoring 67
5.3.2.3 Credit Scoring Versus Relationship Lending: The Role of Organizational Structure 68
5.3.3 Other Innovative Lending Techniques 69
5.3.3.1 Use of Psychometrics 70
5.3.3.2 Judgmental Score Cards 70
5.3.3.3 Peer-to-Peer Lending 71
5.4 Lending Infrastructure 72
5.4.1 The Economics of Information 74
5.4.2 The Legal, Judicial and Bankruptcy Environment 75
5.4.3 The Tax and Regulatory Environment 75
References 76
Part IV Determinants of Loan Contract Terms 80
6 Determinants of SME Loan Contracts 81
6.1 Determinants of Risk Premium on SME Loans 81
6.1.1 Borrowing Firm's Characteristics and Risk Premium 81
6.1.1.1 Firm Size 81
6.1.1.2 Firm's Age/Opacity 82
6.1.1.3 Availability of Collateral/Guarantees 83
6.1.1.4 Firm/Owner's Credit Rating 83
6.1.2 Lender Characteristics and Risk Premium 84
6.1.2.1 Cost of Funds 84
6.1.2.2 Cost of Risk and Cost of Holding Capital 84
6.1.2.3 Administration Costs 85
6.1.3 The Role of Relationships in Loan Pricing 86
6.1.4 External Factors Affecting SME Loan Pricing 87
6.1.4.1 The Credit Channel of Monetary Policy 87
6.1.4.2 The Credit Market Structure 88
6.1.4.3 Business Cycle Fluctuations 88
6.2 Determinants of Collateral on SME Loans 89
6.2.1 Collateral and Loan Characteristics 89
6.2.1.1 Loan Size 89
6.2.1.2 Loan Purpose and Duration 89
6.2.2 Collateral and Borrower Risk Characteristics 90
6.2.2.1 Firm Size 90
6.2.2.2 Firm Risk Rating 90
6.2.3 Collateral and Lender Characteristics 91
6.2.3.1 Collateralised Lending Versus Monitored Lending 91
6.2.3.2 Lender Type and Specialization 91
6.2.4 Collateral and Loan Relationships 92
6.2.5 Collateral and External Factors 92
6.2.5.1 Competition 92
6.2.5.2 Macroeconomic Conditions 92
References 93
7 Conclusions and Practical Implications 96