Durguner, S. “Do Borrower-Lender Relationships Still Matter for Small Business Loans?” Journal of International Financial Markets, Institutions & Money (2017).
The relationship between the borrower and lender has always been known to be an integral factor in the loan approval process. As the lender gains more information on the borrower through a longer relationship, the terms of the loan will change. This can come in the form of reduced interest rates when the trust between the borrower and lender grows, or it can come in the form of a quicker approval process.
However, the recent development of technologies that enable lenders to gather data on a loan applicant via an online application has led the distance between lenders and loan applicants to grow significantly. Beyond the application process, technology has also transformed the loan approval process with automated credit scoring models being implemented by most lending institutions. These technologies limit the amount of interaction between the borrower and lender.
Durguner explores these transformations within the lending sector to explore how these changes have affected the importance of the borrower-lender relationship. The author also finds that the role of the borrower-lender relationship has decreased for some aspects of the credit approval process and has become more important for other areas.
What this means for food and agribusiness
Credit is a vital input in the production cycle. Some businesses rely on the continual flow of financing to operate. Thus, ensuring this input is available when needed and at the lowest cost is of utmost importance. Traditionally, the relationship the lender forged with the loan applicant served as the main avenue for collecting information on the potential borrower.
Many people don’t realize what information goes into the loan approval process. The “Five Cs” of credit are character, collateral, capacity, capital and conditions. Most credit scoring models, even for the largest banks, are loosely based on the “Five Cs”. Before the technology disruption, it was the loan officer’s duty to collect the majority of the information that determined availability of credit and its terms. In some instances, like the determination of a business’s character, this means the loan officer is making a value judgment on the business owner’s ability to effectively manage their business. It isn’t hard to see why the borrower-lender relationship affected the terms of the credit.
The author of this research finds that the intensity, or length, of the borrower-lender relationship has diminished from what it once was. In fact, they find that it is no longer a factor in the determination of credit availability. This isn’t a surprise given the prevalence of automated approval systems that utilize a more data-driven approach. That’s why a business’s hard numbers are even more important for credit approval. Lenders are now increasingly worried about certain metrics such as the business’s debt-to-asset ratio or profit-to-liabilities ratio. For businesses seeking credit, this implies that they need to be cognizant of their own metrics that the lenders are looking at and know how their business practices are impacting these numbers.
On the other side of the issue, the author finds that the borrower-lender relationship has increased its influence for determining the terms of the credit offered. It was found that the longer the lending relationship and the more intense the relationship (e.g. doing the majority of your business with the particular lending institution), the more favorable the credit offering to the borrower. Having spoken with lenders who have indicated an increase in competition amongst peer lending institutions, this is an outcome of the online loan applications. Since it is now easy for a borrower who is seeking credit to fill out an online loan application, it has increased the competition amongst lenders. It is easier now than ever for a borrower to obtain credit from a lender they have never met and is quite possibly not located in the vicinity of the borrower. This means that the lender is offering a loyalty discount to those borrowers who have utilized their services in the past and are doing the majority of their business with that respective lending institution. Borrowers will benefit from consolidating their banking activities in the form of more favorable credit terms.