On the Profitability and Cost of Relationship Lending
34 Pages Posted: 13 Jan 1998
Date Written: July 1997
We provide evidence on the costs and profitability of relationship lending by banks. We derive bank-specific measures of loan rate smoothing for small business borrowers in response to exogenous shocks to their credit risk and to interest rates, and then estimate cost and profit functions to examine how smoothing affects bank costs and profits. Our results suggests that, in general, loan rate smoothing in response to a credit risk shock is not part of an optimal long-term contract between a bank and its borrower, while loan rate smoothing in response to an interest rate shock is.
JEL Classification: G21, G30, L14
Suggested Citation: Suggested Citation