Banking on Deposit Relationships: Implications for Hold-Up Problems in the Loan Market

Abstract

By lending to a firm, inside banks gain an informational advantage over outside banks, enabling them to hold up borrowers and extract informational rents. Using unique data on firm-bank deposit and lending relationships in Norway, we show that deposit relationships between firms and outside banks mitigate inside banks’ informational advantage, thereby attenuating hold-up. This result holds using quasi-random variation in deposit relationships induced by the deposit insurance threshold, and is driven by the information provided by firms’ deposit account activities to outside banks (not cross-selling). Overall, our paper offers the first evidence that deposit relationships impact lender competition.

Keywords: Deposit relationships, Hold-up problems, Lender competition, Lender switching, Information asymmetries

JEL Classification: G21, D82, L10