The Role Of Bank Outside Opportunity In Small Business Lending

In this paper, we developed a 2 stage financial contract model to explore the role of outside opportunity cost in SME finance. We find that big banks with outside opportunity will refinance SME if the expect profit of finance is more than the profit of outside opportunity, whereas small banks who do not have any outside opportunity will refinance SME under more flexible condition. When the cost of gathering "soft information" is lower than critical value, all banks will refinance SME with "soft information" technology. But if the cost of gathering information is higher than critical one, Big bans will shift to outside opportunity while small banks will refinance and opt to use "soft information" technology. The study of this paper offered an explanation to the "size effete" and "technology effect" of SME finance. The "outside opportunity cost theory" in this paper also shed light on policy decision of banking industry.