Just like a personal relationship, a great lending relationship takes time to build. It depends on compatibility between the people involved, and it’s not always straightforward. Relationship lending is improving access to funding for small businesses while building support for local economies – and generating unique types of data and information that can benefit the development of better loan and financing products over time.
Under relationship lending, banks acquire information over time through contact with the business, its owner, and its local community on a variety of dimensions and use this information in their decisions about the availability and terms of credit. Studies have found that lenders who acquire greater relational information from their client firms or businesses tend to experience lower rates of default.
By numerous accounts, business banking customers are more satisfied with their financial institutions when they experience personalized service, and smaller financial institutions have traditionally held an edge over bigger financial institutions in this regard given their smaller customer base and proximity to the community. The longer a lending relationship lasts, the more likely it is that credit availability and cost of borrowing become more favourable for the borrower. However, the checks and balances on the lender come in the form of increased focus on risk management and assessment. Lenders that draw loans and deposits from their local markets may be vulnerable to local economic slowdowns precisely because they have locally concentrated loan and deposit customers.
The types of information that a lender can access are sortable into “soft” and “hard” categories. Soft information is generally more qualitative in nature, and has to do with the borrower business’ existing suite of relationships with people like their suppliers, online feedback providers, business bureau and so forth. Hard information is more qualitative, and based in observations from financial statements, credit scores, etc.
At the start of a relationship, many decisions are based on hard information. Over time, however, the soft characteristics of a business will be of greater and greater importance in the maintenance of financing for the business. As the relationship lending process evolves, both the lender and the borrower are able to insulate themselves from shocks or crises at the operational level or in the economy and market at large.