Relationship Lending, Asymmetric Information And Small & Medium Business Finance

When asymmetric information exists between the demand and supply of fund, thedebtors know more about its credit status and the condition of the investment, as aresult adverse selection and moral risk may incur. In order to control this riskcreditors, such as banks, will exam the debtors' financial statements, requiremortgage or guarantee, or regulate the use of fund. But sometimes these methods areinvalid. For example, when it comes to small business, sole proprietorship or farmers,their financial statements may be suspect, and assets are not enough for mortgage.Different from these traditional lending techniques, relationship lending induces along-term, stable relationship between banks and their clients. So enough interiorinformation can be gained, and loan can be made according to this information.China is just in the progress of economic system revolution, and marketeconomy has not been established completely yet. Asymmetric information is veryserious in financial market while the market is not perfect and the participators ofmarket are immature. So it's meaningful to research relationship lending, and studyits feasibility and contribution in China.This paper firstly reviews the literature about relationship lending. The literature,most of which is from the western countries, including definition of relationshiplending and its course, the benefit and cost of relationship lending, relationshiplending and the credit availability and cost of enterprises. The paper also surveys theresearch methods of the literature. Besides that, it tries to interpret relationshiplending by modern financial theory, and finds that modern financial intermediationtheory, imperfect contracts theory and asymmetric information theory are helpful tointerpret relationship lending.After that, the paper turns to study the practice of relationship lending. A studyof practice and an empirical analysis and are introduced.Firstly, it studies the practice of relationship lending in foreign countries, andUS and Japan are set as examples. In US, relationship lending is used for smallbusiness finance, while in Japan relationship lending is run as main bank system. Itshows that under different financial system, the form of relationship lending varies.Comparing to this foreign experience, the paper starts to analyze some existingrelationship lending in our country, such as main bank system and informal finance.Plenty practice experience, both foreign and domestic, lies a solid foundation for theresearch of application of relationship lending in China.Then event study method is used in the empirical analysis to test the impact ofrelationship lending – figured by line of credit -to listed companies' stock price. Theconclusion finds the positive impact but it's only statistically evident very weakly.Maybe it's because of the poor efficiency of the stock market, or the researchmethod.The last part of the paper chooses the problem of small and medium business(SMBs) finance to research the application of relationship lending. Somecharacteristics of SMBs make it difficult for banks to use traditional lendingtechniques to make loans to SMBs, so relationship lending is very valuable. In thelife cycle of an enterprise, relationship lending plays a key role in some stages, suchas initial stage, because relationship lending of banks may be the main source of fundfor SMBs. But unfortunately, this research finds that relationship lending cannotfunction effectively in China because of some obstacles, such as financial repression,and it ends up that SMBs finance problem is hard to solve. With these facts, thepaper proposes some suggestions to offer optimum condition for relationship lendingapplication. These suggestions can be classified into lending techniques innovationand improvements of the system.