How much do financial institutions really care about relationships?
How do you measure the value of a relationship? One way is forbearance—what the involved parties would give up to stay together. That's the principle used by Stephen Karolyi, associate professor of finance at the Costello College of Business at George Mason University, in his co-authored research on relationship lending in the banking industry.
Researchers have estimated that financial institutions forgo enforcement benefits worth 11.6% of loan value to preserve borrower relationships, according to a study published in the Journal of Financial Intermediation. This "relationship premium" is higher for borrowers who are more mysterious to the wider marketplace and those with fewer financing options.
The study, co-authored by Stephen Karolyi, Andrew Bird, Michael Hertzel, and Thomas G. Ruchti, examined loan packages from 1990 to 2016 and found that lenders choose not to enforce covenant violations to maintain the relationship, which provides benefits such as information gathering and reduced uncertainty.
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