This paper briefly reviews the contemporary literature on relationship banking. We start out with a discussion of the raison d’être of banks in the context of the financial intermediation literature. From there we discuss how relationship banking fits into the core economic services provided by banks and point at its costs and benefits. This leads to an examination of the interrelationship between the competitive environment and relationship banking as well as a discussion of the empirical evidence.

This paper investigates private-interest, public-interest, and politicalinstitutional theories of regulatory change to analyze state-level deregulation of bank branching restrictions. Using a hazard model, we �nd that interest group factors related to the relative strength of potential winners (large banks and small, bank-dependent �rms) and losers (small banks and the rival insurance �rms) can explain the timing of branching deregulation across states during the last quarter century. The same factors also explain congressional voting on interstate branching deregulation. While we �nd some support for each theory, the private interest approach provides the most compelling overall explanation of our results. I.

Although monitoring borrowers is thought to be a major function of financial institutions, the presence of other claimants reduces an institutional lender's incentives to do so. Thus loan contracts must be structured to enhance the lender's incentives to monitor. Covenants make the effective maturity, and the ability to collateralize makes the effective priority, of the loan contingent on monitoring by the lender. Thus both covenants and collateral can be motivated as contractual devices that increase a lender's incentive to monitor. These results are consistent with a number of stylized facts about the use of covenants and collateral in institutional lending. Modern finance theory suggests that financial intermediaries such as commercial banks, insurance 1 companies, and finance companies monitor and control their borrowers on behalf of other investors. This paper investigates how the loans made by these institutions can be structured so as to best enhance these institutions ' role as delegated monitors. Covenants and collateral are common features of loans made by financial institutions, but these features are somewhat difficult to justify. Consider loan covenants- clauses in a loan contract which require the borrower to take or refrain from various actions. Berlin and Mester (1992) and Park (1994) show that, by giving institutions the right to renegotiate or call loans when covenants are violated, covenants serve as

The German financial market is often characterized as a bank-based system with strong bank-customer relationships. The corresponding notion of a housebank is closely related to the theoretical idea of relationship lending. It is the objective of this paper to provide a direct comparison between housebanks and ``normal'' banks as to their credit policy. Therefore, we analyze a new data set, representing a random sample of borrowers drawn from the credit portfolios of five leading German banks over a period of five years. We use credit-file data rather than industry survey data and, thus, focus the analysis on information that is directly related to actual credit decisions. In particular, we use bank-internal borrower rating data to evaluate borrower quality, and the bank's own assessment of its housebank status to control for information-intensive relationships. The major results of our study support the view that housebanks are able to establish a distinct behavioral pattern consistent with the idea of long-term commitment. We find that housebanks do provide liquidity insurance in situations of unexpected deterioration of borrower ratings. With respect to loan pricing, we find no evidence for intra- or intertemporal price differentiation related to housebanking.

One of the more dramatic financial events of the late 1980s and early 1990s was the surge in Japanese stock prices that was immediately followed by a very sharp decline of more than 50 percent. While the unprecedented fluctuations in Japanese stock prices were domestic financial shocks, the unique institutional characteristics of the Japanese economy produce a framework that is particularly suited to the transmission of such shocks to other countries through the behavior of the Japanese banking system. The large size of Japanese bank lending operations in the United States enables us to use U.S. banking data to investigate the extent to which this domestic Japanese financial shock was transmitted to the United States, as well as to identify a supply shock to U.S. bank lending that is independent of U.S. loan demand. We find that binding risk-based capital requirements associated with the decline in the Japanese stock market resulted in a decline in commercial lending by Japanese banks in the United States that was both economically and statistically significant. This finding has added importance given the severe real estate loan problems currently faced by Japanese banks. How Japanese bank regulators decide to resolve these problems will have significant implications for credit availability in the United States as well as in other countries with a significant Japanese bank presence.

Concern with the potential effect of bank mergers on small business lending has stemmed from a belief that larger acquirers may be less willing than their smaller targets to be active in the small business lending market. However, we find that in roughly half the commercial and savings bank mergers of the past three years, the acquirer has a larger portfolio share of small business loans than its target; moreover, the most common acquirer of small banks is another small bank. The empirical results support the hypothesis that acquirers tend to recast the target in their own image, causing small business loan portfolio shares of the consolidated bank to converge toward the pre-merger portfolio share of the acquirer. Since acquirers are almost as likely to have larger as smaller shares of small business loans in their portfolios, compared to their targets, this suggests that not all mergers will shrink small business lending; many will actually increase it.

As protectors of the safety and soundness of the banking system, banking supervisors are responsible for keeping banks ’ risk taking in check. On-site examinations, off-site surveillance, and capital requirements are some of the tools that supervisors use to achieve this goal. Franchise value— the present value of the stream of profits that a firm is expected to earn as a going concern—makes the supervisor’s job easier by reducing banks ’ incentives to take risk. In banking, sources of franchise value include efficiency, access to markets protected from competition, and valuable lending relationships. Franchise value can help reduce excessive risk taking because banks with high franchise value have much to lose if a risky business strategy leads to insolvency.

Governors or its staff. For comments, we thank Mitch Berlin, Erik Berglöf, Øyvind Bøhren, Yehning Chen,

Small banks are a major source of credit for small businesses. As banking consolidation continues, will a resulting decline in the presence of small banks adversely affect the availability of that credit? In May 1995, Texas became the first state to opt out of the interstate branching provision of the Riegle-Neal Interstate Banking and Branching Act of 1994. In Texas, foes of interstate banking and branching voiced a concern over how consolidation might affect small business lending and community development. If small banks are increasingly acquired by large, superregional banking companies, they argued, consolidation will have a negative effect on the availability of credit to small businesses and communities. Proponents countered by arguing that despite consolidation, the need for independent community banks will remain, leaving an

This paper draws on our new database on bank regulation and supervision in 107 countries to assess different governmental approaches to bank regulation and supervision and to evaluate the efficacy of specific regulatory and supervisory policies. First, we assess two broad and competing theories of government regulation: the helping-hand approach, according to which governments regulate to correct market failures, and the grabbing-hand approach, according to which governments regulate to support political constituencies. Second, we assess the impact of an extensive array of specific regulatory and supervisory practices on banking-sector development and fragility. These policies include regulations on bank activities and the mixing of banking and commerce; regulations on domestic and foreign bank entry; regulations on capital adequacy; deposit insurance system design features; supervisory power, independence, resources, loan classification stringency, provisioning standards, diversification guidelines, and prompt corrective action powers; regulations on information disclosure and fostering private-sector monitoring of banks; and government ownership of banks. The results raise a cautionary flag regarding reform strategies that place excessive reliance on country's adhering to an extensive checklist of regulatory and supervisory practices that involve direct government oversight of and restrictions on banks. The findings, which are much more consistent with the grabbing- hand view than the helping-hand view of regulation, suggest that regulatory and supervisory practices that (1) force accurate information disclosure, (2) empower private-sector corporate control of banks, and (3) foster incentives for private agents to exert corporate control work best to promote bank perf...