Essays in relationship banking and small business lending

This dissertation uncovers the black box of relationship lending to small businesses. Using hand-collected, proprietary data from the lending portfolio of a mid-sized regional bank in the United States, I empirically identify the channels that strengthen the relationship between a small business and its bank. In the first chapter, 1 find that information exchange is only part of the mechanism that creates benefits from strong bank tics. I introduce two novel channels of relationship strength that embody an entrepreneur's profit appeal for a bank: (1) the depth of cross-selling of non-loan products to the entrepreneur, and (2) the breadth of additional bank business referred through the entrepreneur's social and professional connections. I show that a borrower's intensive margin of profit (the depth and profitability of cross-selling) and extensive margin of profit (the quantity and profitability of referrals) lower the cost of borrowing and generate access to more credit. These effects are additive. A one-standard deviation increase in both cross-selling and referral profits is associated with a 29 basis point reduction in the loan interest rate and a 21 percent increase in the amount of credit available to a firm.;The second chapter analyzes the function of inter-client social networks in the relationship lending model that characterizes small to mid-sized banks. I find that a key difference between referred borrowers and borrowers who are unconnected to other bank clients is the likelihood of default. After loan origination, the probability of non-accrual is 28 to 49 percent lower for a referred borrower than for an unconnected borrower. The superior loan performance of referred borrowers is particularly salient after the onset of distress. I investigate four possible mechanisms that could drive the disparity between referred and unconnected borrowers' loan performance. I find that improved screening and monitoring play limited roles. Instead, the underlying source of bank value that derives from inter-client referrals is rooted in reputation, marketing, and search costs.;The third chapter studies the behavior of small firms' bank relationships when credit conditions tighten. In particular, I analyze the effect of a firm's pre-crisis bank relationship on its ability to obtain capital during the credit crisis of 2007-2009. I find that the profit channel of relationship strength that derives from the borrower's non-credit profit appeal does not help a firm access credit during a capital crunch. Neither the profitability of a firm's pre-crisis cross-selling, nor the profitability of its pre-crisis referrals, significantly increases the likelihood of getting a loan during the crisis.