EFFECTS OF RELATIONSHIP BASED CORPORATE TRADE FINANCE LENDING ON REFORMULATION OF BANKING CONDITIONS DURING THE 2008
FINANCIAL CRISIS
A CASE STUDY OF THE ECONOMY BANK N.V.
GULCIN ASKIN
UvA Student Number: 10459448 10/09/2014
ABSTRACT
Following Lehman Brothers bankruptcy, the 2008 financial crisis has been one of the most severe financial crises experienced by markets in terms of its widespread effects. Apart from its ongoing effects on countries, nations, governments and households; risk perceptions of market actors and functioning of financial markets have been shaken to its foundations and changed.
As being one of the constituents of financial markets, embodied risks in trade transactions have started to be evaluated differently after the financial 2008 crisis. Parties involving in trade transactions like buyers, sellers, banks, different jurisdictions, commodities and etc. have all increased the perceived risk in a consolidated manner. The effects of financial turmoil on financial institutions’ networking and trust, credit line availability amongst them, available liquidity, commodity prices and cost of funding caused banks to modify their banking terms and conditions that they provided to their clients.
In that sense, relationship based lending has become a referable resort especially for small-scale banks, which are dealing with informationally opaque and SME sized companies. The importance of established relationship throughout the years with these clients has increased during the 2008 financial crisis in reformulating banking terms and conditions on the ground that necessary monitoring activities were cost effective for these clients due to closer ties with them and exploitation of higher rents were possible.
Considering changing market conditions, this paper seeks to address the value of relationship based lending and increased importance of relationship based corporate trade finance lending on reformulation of banking conditions during the 2008 financial crisis by examining The Economy Bank N.V. case.
TABLE OF CONTENTS
I. INTRODUCTION ... 4
II. INTERNATIONAL TRADE FINANCE ... 6
A. PAYMENT METHODS ... 7
III. 2008 FINANCIAL CRISIS AND ITS EFFECTS ... 8
A. EFFECTS OF 2008FINANCIAL CRISIS ON FINANCIAL INSTITUTIONS’NETWORKING AND TRUST ... 10
B. EFFECTS OF 2008FINANCIAL CRISIS ON CREDIT AVAILABILITY ... 11
C. EFFECTS OF 2008FINANCIAL CRISIS ON PRICING ... 12
D. EFFECTS OF 2008FINANCIAL CRISIS ON INTERNATIONAL SMETRADE FINANCING ... 13
IV. RELATIONSHIP LENDING ... 14
A. LENDING TECHNOLOGIES ... 14
B. VALUE OF RELATIONSHIP LENDING ... 15
C. MEASURES OF STRONG RELATIONSHIP ... 16
D. EFFECTS OF RELATIONSHIP ... 18
i. On Credit Line Availability (On Credit Line Amount) ... 18
ii. On Pricing ... 18
iii. On Credit Conditions ... 19
E. CONTRACTING PROBLEMS ... 20 V. CASE DESCRIPTION... 22 A. ORGANIZATIONAL OVERVIEW ... 22 B. CASE QUESTION ... 27 VI. RESULTS ... 28 A. METHODOLOGY ... 28
B. DATA COLLECTION AND LIMITATIONS ... 28
C. DATA AND MATERIALS ANALYSIS ... 29
D. STAFF INTERVIEWS ANALYSIS ... 37
VII. CONCLUSIONS AND DISCUSSION ... 44
VIII. GLOSSARY ... 47
IX. ANNEXES AND REFERENCES ... 51
A. ANNEXES ... 51
ANNEX I ... 51
DATA SUBJECT TO STATISTICAL ANALYSIS ... 51
I. Introduction
Financial markets have experienced many financial crises since the Great Depression but the recent financial crisis prevailing after the bankruptcy of Lehman Brothers in September 2008 was one of the most severe ones in terms of its widespread effects on national economies, banking systems and global trade transactions. Erosion of trust among market actors was followed by a decline in commodity prices and trade volumes (Asmundson et al. 2011).
This paper focuses on the effects of relationship lending on reformulation of banking terms and conditions with a specific focus on trade transactions. Although financing trade transactions is desirable during a liquidity crisis because offset of credit is tied to actual current transactions, due to lack of liquidity at banks’ end, especially small and medium enterprises experienced difficulties to access funding during financial crisis. On the other hand, no matter how severe the turmoil was, banks had to continue operating and post profit as much as possible and this is especially challenging when trust is eroded and liquidity is scarce. In other words, failing market actors caused erosion of trust initially within financial institutions and consequently increased risk perception and squeezed available liquidity. When liquidity became scarce, banks started to follow a more selective approach while investing their capital. Selection criteria may vary from net present value of projects to be financed, financial strength of client, collateral conditions and etc. Under these circumstances, relationship based lending has become one of the resorts for banks while restructuring banking terms of clients in accordance with the requirements of new market conditions, maintaining business as usual and retaining clients since established track records with clients and past experiences are irreplaceable sources of information. When information in the market is asymmetric, moral hazard and adverse selection problems have become more common and in order to overcome these issues relationship based lending has become a valuable solution.
Relationship lending is based on soft information, which is gathered by interactions with clients by the bank throughout the years, and the strength of the relationship is determined by the duration of relationship, usage of multiple services provided by the bank and exclusivity of the relationship according to literature. These factors contribute in decisions taken with
collateral conditions. Especially during financial crisis, banks engage in relationship lending restructure and redesign their pricing, credit line availability and collateral conditions relying on these factors. I expect stronger relationships to serve both clients’ and bank’s interests especially during financial crisis. Because, as clients with stronger relations benefit from better credit conditions, lower prices and more credit line availability on the one hand, stronger relations help bank to consensually reformulate its banking conditions with clients in line with the bank’s terms and sustain its business by maintaining financial support to its clients in a modified extent on the other.
This paper will present findings from existing literature and discuss how relationship based lending affected pricing, credit line availability and collateral conditions after 2008 financial crisis by focusing on The Economy Bank N.V. case. Additionally, determinants of strength of relationship and their implications in practice will be discussed based on data collected from the bank’s records and staff interviews.
The question to be answered through extensive literature review and case study will shed light on the benefits and costs of relationship based lending while maintaining operations during financial turmoil. This paper will also give further insight into the effectiveness of factors that determine the strength of a relationship by means of literature review. Moreover, overcoming information asymmetries through established relationships will be discussed as well. Besides, by exemplification of the case study, this paper attempts to bring together many separate subjects about relationship based lending covered by literature. In that sense, effects of relationship on more credit line availability (Berger and Udell, 1995), more favorable credit conditions (Berger and Udell, 2001) and pricing will be covered in the paper. Contradictory ideas of Berger and Udell (1995), Petersen and Rajan (1994) and Degryse and Cayseele (2000) described in the literature about effects of relationship based lending on pricing will occur at the same time specific to case study. In addition to factors explaining the strength of a relationship in the literature, such as duration of relationship, usage of multiple services and exclusivity, staff interviews provide us additional factors affecting the strength of a relationship such as type of collateral and financial information provided by the company.
Within the framework of this paper, I will discuss international trade finance and its operational dynamics to shed light on the reasons to finance trade transactions in Chapter II.
Chapter III will provide compact data log about the emergence of 2008 financial crisis and its effects on trade financing. This chapter has informative purposes to envisage the background atmosphere of financial markets during 2008 and 2009. Chapter IV will largely cover literature review about lending technologies and relationship based lending. Factors affecting strength of a relationship, added value of relationship based lending and its effects on pricing, collateral conditions and credit line availability will be discussed in this chapter based on literature review. In Chapter V and VI, I will present The Economy Bank N.V. case, data analysis and results. The case study will help me to test whether the importance of relationship based lending increased after financial turmoil and accordingly whether companies with stronger relationships benefit from better credit conditions, lower price rates and higher limit availability especially during times of turmoil when banks demand more collateral, push companies to bank in line with their own terms, increase pricing and decrease limit availability.
While conducting my research, I used empirical data on a set of transactions to test if the trade financing terms and conditions have become more dependent on stronger relationships with clients after financial turmoil. Additionally, staff interviews were used to observe the changing mindset and approach while determining credit conditions after credit crunch.
II. International Trade Finance
Exchange takes time (Ahn, 2011). For instance, Ahn (2011) clarifies that when a supplier agrees with a buyer, it receives a purchase order that provides payment after delivery. The seller has to produce, manufacture or make the goods ready and ship them before the buyer pays. This requires financing at supplier’s end because the supplier may need to borrow working capital to complete the order or financing may take place at the buyer’s end to finance the purchase of the goods. This is the essence of trade finance. Financial institutions play an important role in reducing frictions between buyers and sellers by facilitating and financing trade transactions. Especially international trade finance is dominantly dependent on financial institutions and banks issuing letters of credit (Ahn, 2011).
International trade is more risky than domestic trade because of the longer time gap between production of goods and revenue generation from the sales due to longer transportation times, and documents to formalize international trade (Ahn, 2011). Moreover, considering
counterparty, country and different jurisdiction risks involved in international trade, it is riskier than domestic trade (Ahn, 2011). Additionally, when companies in two different countries with weak contract enforcement trade with each other in order to solve the moral hazard and the problem of defaulting, they usually prefer bank financing (Schmidt-Eisenlohr, 2011), because enforcement between banks is easier when compared to two trader companies. Enforcement between banks is easier because most banks have to hold licenses to operate and they are compliant with international rules and regulations. In case of violation of de facto rules they are subject to, banks face serious penalties and sanctions. Moreover, banks can guide and instruct their clients in order to alleviate risks stemmed from being located in different jurisdictions, ever-changing regulations and document preparation. Additionally, banks may reject issuing letters of credit to some banks or receiving letters of credit from some other banks considering risks involved due to low credit score of these banks or due to their jurisdiction. Thus, allocation and evaluation of risk is more important in international trade finance. Accordingly banks invest more in learning about firms with which they have transactions. When a crisis hits, accumulated information becomes more significant because crisis raises uncertainty (Ahn, 2011). Unlike other recent financial crises, the 2008 financial turmoil had global effects on every type of financial institutions. As a result, the creditworthiness of issuing and receiving banks has added to a general increase in business risk and led to increase in the cost of trade finance (Ellingsen & Vlachos, 2009).
A. Payment Methods
There are several payment methods used widely to allocate risk and to finance the time gap in international trade finance (Ahn, 2011). These are broadly classified into exporter finance (open account), importer finance (cash in advance) and bank finance (letter of credit). When a buyer makes payment after delivery (i.e. open account), a supplier is exposed to non-payment risk from the buyer (Ahn, 2011). Likewise, when a buyer purchases against advance payment to supplier (i.e. cash in advance), the buyer is subject to non-delivery risk from the supplier (Ahn, 2011). Thus, if a bank provides financing for a transaction, it bears not only the performance risk of its own client but also the risk of the counterparties involved. By investing in information acquisition, banks can improve the repayment performance of granted loans in relation with letters of credit.
Ahn (2011) argues that the asymmetric nature of international trade transactions increases the significance of letter of credit system. Under the letter of credit system, both a buyer’s bank and a supplier’s bank are involved in the transaction. The buyer’s bank undertakes to pay the supplier’s bank on behalf of the buyer when goods are delivered and the supplier’s bank undertakes to pay the supplier whether or not the buyer’s bank performs payment (Ahn, 2011). In other words, the supplier shifts the risk of non-payment to the supplier’s bank and the supplier’s bank shifts the same risk to the buyer’s bank. Banks are more willing to provide trade-financing loans because they may control the shipment, delivery and payment schedules. Trade financing is more secure than providing conventional cash loans because each transaction subject to financing is presented and agreed upfront, the loan is utilized for certain transactions, and it is not common to use the funds for other purposes, and control over the goods is in place.
III. 2008 Financial Crisis and Its Effects
The financial crisis of 2007 and 2008 has become the most severe financial turmoil since the Great Depression. The inflated housing bubble caused many banks to record non-performing loans and losses when it burst (Brunnermeier, 2008). Two trends in banking industry contributed significantly to the lending boom and housing abundance that constructed the base for the turmoil (Brunnermeier, 2008). First, banks moved to an “originate and distribute” model by bundling mortgages and other types of loans together and offered collateralized debt obligations (CDOs) and instead of keeping these assets in their balance sheets they transferred them to “special purpose vehicles” to off load the risk. Second, banks started to finance their assets dominantly with short-term liabilities, which exposed these banks to scarcity in terms of funding liquidity. In a nutshell, banks were heavily exposed to maturity mismatch both by lending loans off balance sheet vehicles and their increased dependency on short term financing (repo financing).
These structured products have become popular quickly because risk can be shifted to those who wish to bear it. This leads to lower mortgage and interest rates on corporate and other types of loans. On the other hand, the regulatory environment allows investors to enjoy lower capital requirements for securitized assets held. Rating institutions failed to downgrade banks sponsoring special purpose vehicles since short-term assets on the balance sheet improved the overall rating and toxic assets were recorded in the balance sheets of these special purpose
vehicles (Brunnermeier, 2008). Although toxic assets were recorded in the balance sheets of SPVs, it did not make banks immune and they remained exposed to these risks.
Since risk is shifted to other financial institutions or not carried by sponsor banks’ own balance sheet, securitized products created cheap credit supply and lower lending standards. Additionally, statistical models evaluating the risk of these products optimistically estimated that an extended downturn in house prices was unlikely. Accordingly, mortgage loans were granted without having background checks since house prices are assumed to rise only (Brunnermeier, 2008).
On the other hand, buyers of these securitized assets can purchase credit default swaps (CDS) to protect themselves from default risk by paying a periodic fixed fee. Accordingly, an investor who holds CDOs, insures himself by purchasing CDSs, and from the investor’s point of view, CDOs have become very low risk investments. The problem is noticed when cost of insuring a bundle of mortgages started to increase, which is based on CDS prices. This deteriorated the prices of mortgage related products. In other words, when insurance cost of a bundle of mortgage loans started to increase, the risk associated with mortgage loans increased as well. Accordingly, mortgage related upfront paid CDS fees increased.
Rating companies; Moody’s, S&P and Fitch, announced downgrades for tranches of securitized and structured products in June and July 2007. Following the downgrades, victims of the crisis started to pop up. When defaults had become public, money market participants become reluctant to lend to each other. The downfall started to scramble with the collapse of the investment bank Bear Stearns in March 2008. It was followed by takeovers of Fannie Mae and Freddie Mac, government sponsored enterprises, by the US Treasury in September 2008. Then, the fourth largest investment bank in the U.S., Lehman Brothers, announced bankruptcy in September 2008. Like investment banks, AIG, an American multinational insurance corporation was active in credit derivatives and CDS operations. A bail out plan for AIG was announced right after the bankruptcy of Lehman Brothers in September 2008. The U.S. Federal Reserve stepped in several times by injecting cash and lowering interest rates to alleviate the liquidity crunch but could not avoid spilling over of problems to “Main Street” (Brunnermeier, 2008). Thus, credit availability for firms, governments, and households tightened. Additionally, against all rejections to government interventions, ordinary taxpayers bore the expenses of bail out plans.
A. Effects of 2008 Financial Crisis on Financial Institutions’ Networking and Trust
Financial turmoil still has ongoing effects on economies, mindsets and households but its effects on the lending channel and financial institutions’ network are important to mention within the framework of this paper. In terms of the lending channel, banks faced two main problems after financial turmoil. The first is the moral hazard in monitoring, which arises when the net worth of the intermediaries’ stake falls because intermediaries may then reduce their monitoring effort, forcing the market to fall back to direct lending without monitoring (Holmström and Tirole, 1997, 1998). In other words, decreased net worth and less capital to spare for monitoring efforts brought a moral hazard problem. When monitoring is not included in lending decisions or its contribution is limited, moral hazard is inevitable. Second is precautionary hoarding, which arises when lenders think they may suffer from interim shocks and access to funding will be endangered for their own operations. The latter has consequences in terms of network effects of financial crises. Since banks are both lenders and the borrowers at the same time, they are interconnected with each other through interest rate swap agreements. To put it in a different way, banks engage in interest rate swap agreements with each other to undertake and guarantee their positions as lenders and borrowers for the next transaction day. Relying on these agreements, they park cash deposits, repurchase them and conduct asset and liability management related transactions all day. Although all involved parties think that they hedge their positions with multilateral netting arrangements, none of them is aware of the contractual obligations of any other party. After Lehman’s bankruptcy in September 2008, all major investment banks were worried that their counterparties involved in multilateral netting agreement might default (Brunnermeier, 2008). When a lender has some doubts in terms of the borrower’s ability to meet its obligations, lender might choose to save or invest instead of borrowing. Additionally, when there are reservations at lender’s end in terms of providing financing, not only the current borrower’s but also the current lender’s ability to meet its obligations might be subject to questioning in case the lender needs liquidity. Keeping this behavioral aspect of financial markets in mind, the lender’s unwillingness to lend and cautiousness due to doubts related to borrower’s repayment performance cause erosion of trust and squeezed liquidity in the end.
Erosion of trust quickly affected the interbank borrowing rates and line availability among banks. Increase in interbank rates raised the reluctance of banks to borrow from each other on the money market. Under squeezed liquidity and increased uncertainty, banks followed a wait and see approach before getting into long-term obligations with their clients.
Table I: Interbank Borrowing Rates During 2008
Month / LIBOR Rate 2008 High Low Average
January 4,451% 3,164% 4,037% February 3,277% 3,055% 3,122% March 3,862% 2,648% 3,088% April 3,037% 2,391% 2,610% May 2,588% 2,109% 2,257% June 3,606% 2,068% 2,232% July 2,541% 2,098% 2,247% August 2,253% 2,096% 2,175% September 6,875% 2,130% 3,044% October 5,375% 0,406% 2,129% November 1,163% 0,322% 0,531% December 1,087% 0,110% 0,280% Source: http://www.global-rates.com/interest-rates/libor/american-dollar/2008.aspx
An increase in the bank default risk deteriorates the information encountered between banks and leads to lower credit availability and higher prices charged on letters of credit and funding.
B. Effects of 2008 Financial Crisis on Credit Availability
Most of the banks somewhat lost confidence in letters of credit issued by buyers’ banks due to the handicap of buyers to pay. Letters of credit issued by buyers are usually financed (backed up) by working capital loans or incoming letters of credit. When access to financing is limited, a buyer might have difficulties to meet its obligations under a letter of credit, which is simply a payment obligation of a buyer when goods are delivered. Banks involved in letter of credit related transactions undertake to repay to the seller’s bank on behalf of the buyer when the seller meets its obligations. On the other hand, an issuing bank, which suffers from a lot of non-performing letters of credit due to poor performance of buyers (or its clients), will eventually fail to meet its payment obligations under letters of credit to other banks. Accordingly, the popularity of the letter of credit instrument has diminished, and the slow down in the global economy together with the decrease in global trade volume have translated
into a drop in the use of all trade finance instruments (letters of credit and short term working capital loans) (Malouche, 2009). This is mainly due to the supply effect because the slowdown in the real sector was initially triggered by the start of the financial turmoil. When banks became reluctant to intermediate trade transactions and market actors were considered unreliable by banks, first financial institutions terminated their facilities, and then firms involved in global operations copied this action, considering banks should have evaluated and monitored market participants better than commercial entities due to their global networks, accessibility and expertise. Together with the decrease in demand of trade finance products, the risk aversive approach of banks and the difficulty in finding creditworthy clients contributed to the trade volume decline as well.
In line with the decrease in demand, the availability of trade finance tightened as well. Banks play a central role in facilitating trade by providing financing and managing payment mechanisms such as telegraphic transfers and letter of credits. Data from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) indicates that the number of trade finance messages declined by 4.8% in December 2008 compared to the same period in 2007 (Chauffour and Farole, 2009). This decrease is both because of demand and supply effects, because the global decrease in trade volume reduced companies’ need for financing, and banks’ risk aversive approach, together with their reluctance in lending, contributed to the decrease in total.
C. Effects of 2008 Financial Crisis on Pricing
As the financial crises unfolded, due to above-mentioned problems, the cost of trade finance increased because of growing liquidity pressure and the perception of higher country and counterparty risks. Together with the turmoil, the price of trade finance and the need for securing trade transactions with guarantees and/or insurance increased significantly since the risk of financing trade transactions started to be considered higher. Accordingly, IMF/BAFT survey indicates that by the end of 2008, trade finance deals were offered 300-400 basis points over interbank refinance rates – two to three times higher than the rates of the year before. The cost of letters of credit was reported to have doubled or tripled for buyers in emerging countries (Asmundson et al. 2011). This collective lack of confidence within the banking system put more pressure on trade finance clients.
D. Effects of 2008 Financial Crisis on International SME Trade Financing Most countries have been affected, but the impact of the financial turmoil was more significant for countries, which are integrated and dependent on international trade (Malouche, 2009). Additionally, Malouche (2009) argues that SMEs have been affected more than large firms because of lower equities and weaker bargaining powers compared to large firms and banks. SMEs and trading companies engaging in global supply chains or industries were constrained both by the banking system and by the slowing down in the global economy. Since SMEs are usually dependent on fewer clients, decrease in demand and lack of new orders directly affected SMEs’ revenue generation (Malouche, 2009). Furthermore, increased selectivity in financing trade transactions and additional guarantee and collateral requirements demanded by financier banks put pressure on SMEs as well.
Relative to standard conventional credit lines or working capital loans, trade finance is relatively illiquid (Chauffour and Farole, 2009). In other words, trade finance loans cannot be used for other purposes easily. They are also well collateralized – loans and insurance are granted directly against the sale or purchase of specific products or services whose value can be calculated and secured. In contrast to these securing features, one other significant aspect of trade finance is its higher risk because of its international context. Cross border trades face macro level risks that could impact the value of return (e.g., exchange rate fluctuations, changes to policies and the probability of default). Additionally, they face specific counterparty risks in relation to the poorly functioning institutions and legal systems in developing countries (Chauffour and Farole, 2009). During the 2008 crisis, it became obvious for financial markets that regulatory authorities misinterpreted the outcomes of possible problems that might emerge in structured products market and did not take precautionary actions to prevent them. Considering the embedded nature of international trade and scope of the financial crisis, banks and companies could not precisely evaluate the risks of countries and counterparties in the early phases of turmoil.
Decreased availability of financing and squeezed liquidity raise interest rates depress the financial ratios on the balance sheets of borrowers, reduce the value of their collateral and lower their credit scores. These deteriorations in creditworthiness make it difficult to make transaction based lending such as financial statement lending, asset based lending or credit
scoring rather than relationship lending. On the other hand, relationship based loans may be affected more than transaction based loans by increased regulatory scrutiny because relationship based loans depend on soft information that cannot be easily justified to the regulators.
To sum up, following the Lehman Brothers bankruptcy, panic prevailed in relation to the health of financial institutions. Despite the efforts of governments, liquidity remained squeezed, the costs of corporate and bank borrowings increased, and volatility in financial markets increased. Under these circumstances, despite the fact that the risk of financing trade transactions increased significantly both because of increased risk of counterparty banks and clients’ performance risk in terms of meeting their obligations, banks which have strong relationships with their clients can manage to reformulate their banking conditions and continue their usual operations by this means. Relying on established relationships, banks may overcome issues stemmed from information asymmetries, market volatility and adverse selection. In other words, during financial turmoil, by restructuring banking terms of clients with long lasting relationships and focusing on these clients, banks manage to avoid risks related to asymmetric information and adverse selection. Because information gathered throughout the years in their relationship provides better understanding of their client’s operations, risks involved and monitoring capabilities to financier bank.
IV. Relationship Lending
A. Lending Technologies
Small business lending by financial institutions can be categorized into at least four main distinct lending technologies: financial statement lending, asset based lending, credit scoring and relationship lending. The first three can be classified under transaction based lending (Berger and Udell, 2002). These two approaches are not mutually exclusive and both types of lending coexist at the same time.
Financial statement lending draws attention on assessing information from the firm’s financial statements. When financial statements are not audited, information derived from financial statements might not reflect the entire reality within the company. On the other hand, this form of lending is more suitable for companies operating for longer periods, more transparent and with solid financials. Asset based lending focuses on the present and future values of the
collateral. Credit scoring uses information from financial statements and creditworthiness of the borrower and weights them to create a credit score (a.k.a. credit rating).
Banks engaged in relationships with their clients obtain information over time through communication with the company, its shareholders and its local community, which is beyond readily available public information (Boot, 2000). Banks can also gather information through contacts with the borrower’s customers and suppliers. This information includes knowledge of the borrower’s repayment history, better understanding of the client’s managerial style, awareness of obscure strengths and weaknesses of the client and other kinds of soft information (Brick and Palia, 2007). This information constructs a basis while evaluating the availability and terms of credit lines to be established for this company. On the other hand, collected information has important value beyond the financial statements, collateral and credit score which helps lender to overcome information opacity and information asymmetry problems better than other transaction-based financiers. Having close ties with clients increases the monitoring abilities of the bank, which might help to receive any signal indicating a financial problem at the company’s end earlier than other financiers during economic downturns.
B. Value of Relationship Lending
Banks engage in relationship lending; monitoring performance of past loans, deposits and other financial products, together with the overall performance of the company and its shareholders on several different contracts as well. Boot (2000), argues three benefits that relationship lending provides to overcome information asymmetry problems and add value. The first benefit is related to information exchange. For instance a borrower might be reluctant to share proprietary information on the financial market in order to avoid competitors getting information and possibly benefitting from it. But when a bank steps in as a financier, the borrower might reveal information without worrying about leakage of that information. When compared to transaction based lending, the borrower might be more willing to share information when it recognizes that the bank is lending and improving its lending conditions according to the revealed information. This explains why sharing information related to the borrower’s core competencies might be more likely compared to transaction based lending, because transaction based lending heavily relies on financial information, net worth of assets and credit scoring. Side information related to the firm’s
operations and competitive advantages are not directly relevant to the lending decision. Accordingly, banks are significant in overcoming problems stemmed from information asymmetry by making the established relationship more sophisticated. The second benefit he mentions is about contractual features that relationship lending accommodates. In other words, relationship lending might provide flexibility and renegotiation opportunity of contract terms over time. For instance, when a dispute occurs, it is easier for both parties to renegotiate covenants and terms of the loan agreement compared to bond issues or any other public capital funding instruments. Lastly, since relationship lending requires closer contact between borrower and lender, it may create better communication between them, which allows lender to monitor the value of the collateral subject to lending. Collateral can mitigate moral hazard and adverse selection problems in loan contracting (Stiglitz and Weiss, 1981) but it is effective when its value is monitored (Rajan and Winton, 1995).
Beyond its benefits in terms of determining collateral conditions and overcoming information asymmetry and moral hazard problems, relationship lending has effects on pricing and credit availability, which will be discussed in the upcoming chapters.
C. Measures of Strong Relationship
Berger and Udell (2002) argue several measures to monitor the strength of a relationship. The duration of the relationship, the extension of the relationship in terms of usage of multiple services or multiple account officers, the exclusivity of the relationship in terms of the bank being the only financier of the company, the level of mutual trust between the bank and the firm and the presence of a main bank (Berger and Udell, 2002). According to them; the strength of the relationship contributes to lower pricing, better collateral conditions and more line availability.
Relationship lending is described as a long-term contract between a bank and its client. Based on information acquisition and repeated transactions with the client throughout the time, private information is accumulated. In that sense, the duration of the relationship is important to gain reliable information and build up a database over time. The longer the relationship period, the more opportunities emerge to intermediate different types of transactions and monitor the client’s performance. The duration of the relationship is important to co-adopt managerial styles and decisions for both the bank and the client. The longer the relationship
is, the more adaptation and alignment of both parties to each other’s business operations are possible.
Usage of multiple services increases the exploited rents from the client on the one hand, and embeddedness of the client into the bank on the other. It is not only important in terms of revenue generation but also important to intensify the daily contact with client and its shareholders. Thus, monitoring clients who use multiple services becomes less costly for the bank.
Moreover, Berger & Udell’s (2001) studies about bank uniqueness suggest that having only one bank as a main lender increases firm value and the strength of the relationship. In addition to Berger & Udell (2001), Boot (2000) suggests as well that relationship orientation can make a bank more valuable to a borrower compared to other competitive banks. Companies share private information since they believe that having close ties with banks will serve them at difficult times. In this context, firms usually have more than one relationship as a precaution in case one financier bank withdraws its support when it is needed. On the other hand, from a bank’s point of view, providing support during difficult times is more likely, ceteris paribus, when the claim of the bank is more senior over the claims of other creditors, the expected bargaining costs are lower and the uncertainty about the real quality of the borrower’s assets is lower (Elsas&Krahnen, 2002).
Additionally, it is not easy for SMEs to switch from one bank to another, especially during financial turmoil, despite the fact that they are banking with more than one bank most of the time. Banks are more willing to continue their relationship with the companies if switching to other financiers is not easy for these borrowers, so that banks can exploit the rents from the relationship to a greater extent (Gobbi&Sette 2012). When the crisis popped up it was unexpected, therefore especially SMEs could not find time to adjust their borrowing structure quickly. And relationship banks may hold these firms up by not granting further credits or by quoting higher rates as these companies have a slight chance to switch from one bank to another especially during crisis (Gobbi&Sette, 2012). Relationship banks can hold up these firms because banks have already captured them.
Having close and long lasting relationship with clients has several impacts on banking terms formulated prior to financing of transactions. Although a bank’s approach to a client may vary depending on the conditions of the market in which they operate, Berger & Udell (1995 & 2001) argue that strong relationships have certain effects on banking terms such as credit line availability, pricing and collateral conditions.
D. Effects of Relationship
i. On Credit Line Availability (On Credit Line Amount)
Line availability means formalization of a relationship between a bank and its clients, and it also represents a forward commitment for the bank to provide financing within the specified terms and conditions. (Berger&Udell, 1995). The relationship effect has more importance when a company is opaque or financially more fragile. Information accumulated throughout the years is embedded in relationship lending and it is more important when it is more difficult to monitor opaque firms, or when firms are in financial distress. Accordingly, a relationship has a positive effect on continuation of existing lines during a crisis. When having close ties with the clients, banks refrain from sudden cancellation of credit lines during economic downturns, keeping in mind that financial markets have a cyclical nature and banks might need to reap the benefits of the relationship during good times.
Additionally, generating more volume with the clients with which the bank has long lasting relationships is more likely because the possible risks that the operations of the clients involve have already been monitored and evaluated by the bank throughout the years. Accordingly, the bank is more prepared for possible risks that might arise when compared to recently acquired clients. Sharing more capital to finance the transactions of relationship clients is a reasonable argument for a bank while allocating more credit availability to these clients.
ii. On Pricing
Berger&Udell (1995) find a negative correlation between relationship length and interest rates. On the contrary, Petersen&Rajan (1994) find no correlation. On the other hand, Degryse&Cayseele (2000) find a positive correlation between relationship duration and interest rates. Since long term fixed pricing is not applied to most of the clients due to the nature of fluctuations in lending rates and global financial markets, the effect of relationship on pricing is two-fold.
Banks might put pressure to increase pricing for clients with which they have been banking for a long time since banks are aware of the fact that it is not possible for clients to be quoted with better pricing by the competitors. In other words, external price shocks that increase cost of funding for banks have widespread effects on financial institutions. When the cost of funding increases for most financial institutions, banks prefer increasing prices instead of booking transactions at a loss. Taking the relationship factor into account, an increase in price is predicated to the clients as a matter of necessity and as a new pricing standard for a specific period of time.
Whereas, apart from the effect of the cost of funding, depending on the relationship with the clients, banks prefer reducing their pricing in case they are aware of the fact that an increase in price may be perceived by the client as taking advantage of unfavorable market conditions and could cause a deterioration in their invested relationship. Additionally, banks may reduce prices for selected clients in order to combine low prices with higher ones and maintain a certain spread over its cost of funding and return on equity at the end of the day for the sake of its own sustainability and profitability.
Accordingly, reciprocity between the bank and its clients has a two-fold effect on pricing depending on the conditions in which pricing is determined.
iii. On Credit Conditions
According to the results of Berger&Udell (2001), borrowers with longer banking relationships are less likely to pledge collateral because banks use gathered information to refine their loan contract terms. Considering that the credit proposals/conditions are renewed/reviewed every year based on the most recent financials, credit rating and changing business conditions; at the beginning of the relationship banks usually try to avoid risks and engage in the most secure credit terms as much as possible. After monitoring the performance of the clients and becoming more familiar with the clients’ needs and business operations, credit conditions might be improved in favor of the clients. A long lasting and flawless relationship with the client not only benefits the client itself by providing more favorable contracts and credit conditions, but also improves the bank’s seniority in the client’s financing structure since the bank that provides better credit conditions takes a larger share from financing opportunities. Gobbi&Sette (2012) argue that the importance of monitoring
borrowers increases during a crisis and banks with close relationships with their clients have a lower cost of monitoring due to their ability to move and take necessary actions fast. Accordingly, modification of credit conditions is easier for the banks, which are engaged in relationship lending. Awareness of ex ante credit conditions and their operability contributes in designation of ex post credit conditions without imposing additional constraints or putting pressure on the client.
E. Contracting Problems
A relationship is soft data by its nature and it is hard to quantify, verify and communicate through the normal channels of a banking organization. Since the account officer is the first person who is in contact with the company most of the time, this information is acquired and stored primarily by the account officer. Relationship lending processes differentiate from other transaction based lending technologies, therefore the organizational form of the bank should be in line with the nature of lending technology to support the account officer and the company. Thus, banks offering relationship lending need to delegate more authority to account officers than banks emphasizing transaction based lending because the soft information held by the account officer is not observed or transmitted to other decision making authorities within the bank.
On the other hand, due to the increased authority of the account officer, the bank might overinvest in lending new loans instead of monitoring existing ones carefully and deteriorating borrower’s conditions might be hushed up. In order to avoid these problems, banks investing in relationship lending should spend more time and resources to monitor existing loans while delegating more authority to account officers. In that sense, to reduce agency problems associated with the relationship-lending period, credit reviews may help to remove layers between account officers and bank management and provide better monitoring. While small sized banks are more advantageous in periodically reviewing their outstanding exposures, large banks may suffer. Thus large banks may choose not to rely on relationship lending as much as smaller banks. Having fewer communication problems and organizational diseconomies lead small banks to invest in relationship information, which is easier for them to transfer from one employee to another due to their size.
Apart from problems stemmed from account officers’ authority, Boot (2000) argues another problem called “soft- budget constraint”, which is stemmed from a lack of toughness on the bank’s part in enforcing the borrower to fulfill its liabilities due to relationship. Accordingly, in case the borrower is aware that renegotiation of contract terms is possible and easy, it may not perform sufficiently to fulfill its liabilities.
Berger and Udell (2002) suggest that large banks usually stay away from relationship lending because they are usually headquartered at a distance especially from small and medium enterprises and they do not have the ability to move fast when a problem occurs. Valverde et al. (2009) argue that relationship lending is more tailor-made while providing lending to informationally opaque SMEs. Although neither transaction lending nor relationship lending are homogenous in terms of the lending technologies applied, smaller domestic banks may have a comparative advantage in delivering relationship lending (Berger and Udell, 2002). Additionally, information hypothesis argues that less competitive banks have more incentive to invest in soft information in order to improve their competitive advantage in the market. Following this, competition among banks and credit availability may matter for SMEs for two more reasons: first, these companies are more subject to information problems, and second, they are more bank-dependent than large enterprises which have access to international capital markets and may raise funds in other ways in case credit lines are not available (Valverde et al., 2009). In other words, companies enjoying the benefits of a close relationship with its bank might suffer in terms of line availability when the market becomes too competitive and does not let banks invest in relationship lending due to short-term client retention expectancy because of harsh competition. This indicates that excessive competition ex post may discourage bank lending ex ante (Boot, 2000). Besides competition and physical distance, foreign ownership, financial distress and being large are other factors, which put barriers to providing relationship lending (Berger et al., 2001).
Literature provides several indicators to determine the strength of a relationship. These are: duration of the relationship, usage of several banking products (or several account managers) and exclusivity of a relationship. Hereafter, literature suggests that a stronger relationship has effects on credit conditions, pricing and credit line availability. Before presentation of the case and the data analysis, I would like to mention the analysis I intend to conduct. Taking available data from the bank into consideration, I would like to analyze the effect of the
relationship on reformulation of banking conditions of companies. In other words, I would like to test whether companies with stronger relationships benefit from better credit conditions, lower pricing and higher limit availability especially during turmoil times when banks demand more collateral, push companies to bank in line with their own terms, increase pricing and decrease limit availability. To put in other words, I would like to test whether the importance of relationship increased while formulating banking terms and conditions after financial crisis. Consequently, I would like to explain the consequences of putting more emphasis on relationship on determining credit conditions, pricing rates and available line amounts.
To test the effects of relationship based lending after crisis, I will conduct empirical data analysis on a set of transactions and clients to present whether certain determinants of strength of a relationship affect trade financing terms and conditions in a positive way. Additionally, in order to explain the consequences of increased importance of relationship based lending, I will conduct interviews to illustrate the changes occurring in the mindsets of employees who are involved in the decision making processes and relationship with clients.
V. Case Description
A. Organizational Overview
The Economy Bank N.V. (TEB NV) is a fully licensed bank with license number 12000039 and is subject to supervision of De Nederlandsche Bank N.V. (The Dutch Central Bank) as well as the AFM (The Netherlands Authority for the Financial Markets). TEB NV is a public limited liability company incorporated on 17 November 1998 in Amsterdam, Netherlands. The main activities of the bank are trade and commodity finance, private banking and retail deposit activities. TEB NV is fully owned by Turk Ekonomi Bankasi A.S. (TEB AS) incorporated in Istanbul, Turkey. TEB AS is a listed company in Istanbul (BIST) and London (GDR) Stock Exchange markets.
In 2005, TEB AS (parent company of TEB NV) became a joint venture of BNP Paribas and Colakoglu Group. BNP Paribas is one of the largest financial groups in the world, and this development has contributed considerably to the overall activities. Thanks to the BNP Paribas Group’s outstanding network, TEB NV has extended its geographic reach to 85 countries worldwide, with an initial focus on North Africa and Eastern Europe-Asia. Colakoglu Group
is an industrial group established in 1945 in Turkey. Colakoglu Group is one of the major iron and steel manufacturers of the region and owned by Colakoglu family. Detailed shareholder structures are depicted below:
Table II: Shareholder Structure of TEB NV
SHAREHOLDER STRUCTURE OF TEB NV
TURK EKONOMI BANKASI A.S. (TEB AS) 100%
TOTAL 100%
SHAREHOLDER STRUCTURE OF TURK EKONOMI BANKASI A.S. (TEB AS)
TEB HOLDING AS 55,00%
BNP PARIBAS YATIRIMLAR HOLDING AS* 23,52%
BNP PARIBAS FORTIS YATIRIMLAR HOLDING AS* 17,25%
PUBLICLY HELD 4,18%
Others 0,05%
TOTAL 100%
*These companies are BNP Paribas Group Companies
SHAREHOLDER STRUCTURE OF TEB HOLDING AS
BNP PARIBAS GROUP 50%
COLAKOGLU GROUP 50%
Figure 1: Shareholding Structure Diagram
The retail banking department collects retail deposits and serves individual depositors, and the private banking department offers banking services and investment alternatives to private clients on an execution-only basis. Among private banking products, offerings are: foreign sovereign and corporate bonds, Turkish local debt instruments denominated in TRY (Turkish Lira) and other currencies, equities, short-term money market deposit facilities, foreign
exchange transactions (spot and forward contracts), currency forwards and swaps, dual currency deposits, BNP Paribas global funds (Parvest), ETF and OTC derivatives.
The trade finance and corporate banking (TFCB) department is where trade and commodity finance activities, handling of loans and credit facilities together with other corporate banking services are provided, including related correspondent banking relationships. TFCB provides import and export letters of credit, documentary collections, guarantees, standby letters of credit, pre-production financing, receivable financing, FCR (forwarders certificate of receipt) financing, bill of lading financing, freight financing, discounting bills and promissory notes, warehouse/stock financing and receivables financing. All corporate clients are evaluated based on financials, sector and other soft factors; trade related clients are evaluated based on the structure of the underlying transaction, position risk, performance risk, the commodity subject to financing itself and compliance risks. All are critical factors in the credit decision process, which starts at the trade and commodity finance department.
Apart from above mentioned departments, the treasury department conducts central treasury functions to manage the bank’s liquidity and currency position, and the financial institutions department maintains relationships with counterparties and establishes networks to facilitate trade financing transactions. Below, the business activities of bank are depicted:
Figure 2: Business Activities in The Economy Bank N.V.
Business Activities Trade & Commodity Finance Financial
Although all of these departments contribute to revenue generation and profitability, in line with the framing of this paper I will focus on the trade finance and corporate banking department. However, apart from the trade finance and corporate banking department, multiple services can be provided to a corporate client only through the private banking department, by investing funds of shareholders of the corporate company.
Since I want to depict the effects of relationship lending during the 2008 crisis and considering the financial turmoil unfolded in the last quarter of 2008, I compared the year-end results of 2008 and 2009. Accordingly, while the trade volume of the bank decreased almost 31%, financial figures maintained their solid structure. In order to present performance of the bank in these years, below detailed tables are helpful.
Table III: Performance Indicators of TEB NV in 2008 and 2009
Thousand EURO 2008 2009 Change %
Total Trade Volume 1.699.483 1.174.571 -30,89%
Letter of Guarantees 109.896 85.990 -21,75%
Import Letter of Credits (outgoing) 500.636 437.283 -12,65%
Export Letter of Credits (incoming) 546.640 314.039 -42,55%
Draft Discounting 31.424 48.844 55,44%
Documentary Collections 510.848 288.415 -43,54%
Source: The Economy Bank NV 2009 Annual Report
Table IV: Performance Indicators of TEB NV in 2008 and 2009
Million EURO 2008 2009 Change %
Loans to banks 189 190 0,53%
Loans to clients 159 217 36,48%
Total Loans 348 407 16,95%
Net Profit 7,34 6,991 -4,77%
Total Equity 77 85 10,39%
Source: The Economy Bank NV 2009 Annual Report
1
TEB NV was obliged to contribute EUR 519,000 to the Dutch deposit guarantee scheme that covers the costs of failing banks in the Netherlands. Accordingly, net profit generated from bank’s own activities was EUR 7,5 million which corresponds 2.3% increase when compared to 2008 year-end results.
Apart from the effects of relationship lending on pricing, credit line availability and collateral conditions of selected clients, lending based on relationships has a positive impact on the bank’s financial figures, which should be discussed separately. In brief, beyond its direct effects on pricing, credit line availability and collateral conditions, relationship lending has a significant effect on sustainable lending, volume and profit generation during the crisis. Despite the decrease in total trading volume in 2009, the increased amount of loans to clients, stable profit and increased equity indicate that relationship based lending allowed the bank to reformulate its banking terms and conditions with its clients and to continue its operations in a profitable manner.
B. Case Question
Many scholars have discussed the effects of relationship based lending. While conducting my research within the company, the bank’s unique nature provided me the opportunity to expand the framework discussed by many scholars before. TEB NV is dominantly providing service for trade finance clients and due to its size and close ties with its clients, it continued to post profit right after the 2008 crisis although it experienced shrinkage in terms of transaction volume. While most of the financial institutions suffered from erosion of trust and squeezed liquidity conditions, despite its size and limited client portfolio, TEB NV enjoyed the fruits of its previous investments in building strong relationships with its clients by increasing the amount of loans to clients, keeping net profit amount stable and increasing equity in 2009.
Effects of the relationship have become prominent when granting new loans, renewing credit lines, structuring credit conditions and pricing transactions. Additionally, relationship lending favored the bank while eliminating information asymmetries, the moral hazard problem and closely monitoring its client portfolio. Considering the 2008 financial crisis as the background atmosphere of the case study, I would like to examine how relationship based lending affected pricing, credit availability and collateral conditions in the example of The Economy Bank NV case. In other words, when lending become more risky due to the consequences of the 2008 financial crisis, how The Economy Bank NV managed to grant loans relying on its relationship with its clients. I would like to analyze the effect of relationship on redesigning credit conditions, price rates and credit line availability. To sum up, relationship lending has appeared as a core competency and competitive advantage for the bank during the 2008 financial crisis, that deserves elaboration.
VI. Results
A. Methodology
The data provided belongs to 2008 and 2009 period. Credit proposals in which credit conditions are described in detail, rating information and amount of available line are considered useful to compare the effects of relationship lending after a financial shock took place in the last quarter of 2008. On the other hand, collecting pricing data was more difficult since most of the transactions after the crisis were evaluated on a case-by-case basis, and pricing decisions were made in accordance with the nature of the transaction. Moreover, selecting the right transactions to reflect the effects of crisis was another issue. Since the outlook in 2008 changed in the last quarter and the immediate effects on pricing lasted long into the first half of 2009, relative normalization occurred after June 2009. Accordingly, in order to have a reasonable comparison in terms of pricing, I chose transactions booked right before August 2008, when Libor rates were at their peak, and transactions booked in August-September 2009 period, when Libor rates were at their lowest level. In other words, transactions belonging to August 2008 period represent the ex ante conditions and transactions belonging to August – September 2009 period represent the ex post conditions.
Finally, similar to Berger and Udell’s (2001) study, I excluded transaction driven loans such as mortgages, equipment loans, motor vehicle loans and other spot loans that small firms may be granted by other banks, in order to avoid diluting my relationship lending results.
B. Data Collection and Limitations
Although the information technology infrastructure of the bank is not advanced compared to large financial institutions, most data is kept in hard copy due to laws and legal regulations. Despite the fact that keeping data in hard copy may result in interruptions in terms of chronological flow of the incidents and information, most of the collected data was mentioned in the forthcoming year’s documentation to provide better grounds for comparison. On the other hand, as an employee of the bank, I have access to detailed pricing information but revealing this information is not allowed due to the bank’s policies. Instead of stating exact pricing of transactions, I prefer presenting changes in percentages to describe ex ante and ex post situations. Additionally, I changed the names of companies listed in the sample size in order to protect confidentiality and the exclusivity of bank’s relationship with these companies.
C. Data and Materials Analysis
I focused on the period between August 2008 and August 2009 since the crisis hit in the last quarter of 2008 and improvements in trade finance started to emerge after the first half of 2009. The 40 clients selected are all part of the global supply chain and operating on an international scale. They are small to medium sized companies and incorporated in several different jurisdictions. They are engaged in trading of metals, minerals, grain and chemicals, which makes them both suppliers and buyers from time to time. I selected these clients because they all continued banking with TEB NV before and after 2008, they are all engaged in trading activities, which makes them a supplier and a buyer at the same time depending on the nature of transactions they are involved in, and they can all be classified as small and medium enterprises.
Small firms are more vulnerable to external shocks because they are dependent on financial institutions for financing, and these companies do not have easy access to the public capital markets. Accordingly shocks causing a cut in the credit line amount severely affect small companies, which are incapable of replacing those facilities provided and then withdrawn by financier bank with another form of financing in a timely and quick manner. Most of the clients of TEB NV are trader companies and financials of these companies do not include significant assets since the nature of the business is based on short-term transactions.
While financing trade transactions, although TEB NV collateralizes the goods subject to financing, credit line availability is not determined based on the type of good to be traded and collateralized. Collateralized assets are dominantly inventory (goods on transfer, goods in warehouses, or etc.) or account receivables depending on the nature of the transaction, and the collateral conditions are parameters but not principles while evaluating credit line availability. Considering the nature of trader firms’ financial statements, which lack high asset and equity sizes, credit scoring is not suitable for the TEB NV client base.
Relying on relationship lending and providing authority to account officers increases the importance of monitoring. In that sense credit reviews that take place every month helped TEB NV to monitor the status of outstanding loans. Credit reviews are important to sort out contracting problems between account officers and the bank’s management as well. Taking the authority and information that the account officer has into account; in order to reduce
agency problems associated with relationship lending, monthly credit reviews remove layers between account officers and bank management and provide better monitoring. TEB NV enjoys the advantage of its small size while organizing credit reviews with the participation of the CEO, the Credits Director, the Marketing Director and the account officer himself. Having less communication problems and organizational diseconomies leads TEB NV to invest in relationship information which is easier for TEB NV to transfer from one employee to another due to its size.
In order to monitor the strength of the relationship with these clients I first checked the duration of relationship with the bank. In other words, I like to present for how many years these clients are engaged in financing activities provided by the bank uninterruptedly.
Secondly, I checked the usage of multiple services provided by the bank. Usage of multiple services implies that shareholders of these companies use private banking activities to invest their personal wealth and/or other companies in which shareholders hold shares are banking with TEB NV. In other words, the clients subject to analysis use more than one account officer directly or indirectly.
Lastly, exclusivity of relationship is taken into account. As I mentioned earlier, most companies prefer banking with multiple banks in order to eliminate the risk of unavailability of credit lines during crisis. On the other hand, taking sample size into account, a few clients have an exclusive relationship with the bank and it is important to present and emphasize that they enjoyed the advantage of their exclusive relationship after the crisis.
Besides, TEB NV conducts internal rating scoring for all of the clients that are provided loans. Accordingly rating information ex ante and ex post to crisis is also provided, but I found that there is no change in average rating of all clients in 2008 and 2009. That is why rating data does not construct a reliable basis to discuss effects of relationship lending during the crisis. The internal credit rating score of the company is determined by internal credit scoring tools, which are run by the account officer himself and stated on every credit proposal. Input data is comprised of operating years in the industry for the client, latest turnover figures, the nature of goods subject to financing and the bank’s control over goods.
In order to monitor the effects of relationship, I first conducted univariate analysis to analyze the effect of duration of relationship, usage of multiple services and exclusivity on determining limit conditions, pricing and limit availability (a.k.a. available limit amount). For all analysis conducted, the confidence interval is determined as 95%. Consolidated statistical results for univariate analysis are depicted below:
Table V: Consolidated Results of Univariate Statistical Analysis
Duration of Relationship (years)
Usage of Multiple
Services (Y/N) Exclusivity (Y/N) Change in Limit Conditions (Y/N) B=0.501 SE=0.172 S=0.004 S=0.204 (Chi square test) S=1 (Chi square test) Change in Pricing (%) B=-0.089 SE=0.041 S=0.036 S=0.066 (Kruskal Wallis test) S=0.010 (Kruskal Wallis test) Change in Limit Availability (%) B= 0.028 SE=0.009 S=0.004 S=0.545 (Kruskal Wallis test) S=0.001 (Kruskal Wallis test)
(Constant, Standard Error, Significance)
I first analyzed the effect of independent variables separately (duration of relationship, usage of multiple services and exclusivity) on change in credit conditions of these clients. Limit conditions are comprised of conditions about financing schema. In other words, as financing goods on transfer has become the least risky type of condition (because most of the time bills of lading are collateralized, i.e. they are legal instruments), financing inventory in the warehouse, due to the longer tenor of its financing nature and possible price fluctuations, has become more risky during crisis. Improvement in credit conditions implies including riskier financing schemas into available lines in order to intermediate more transactions and generate more volume and profit from this client. In order to provide a more comprehensive explanation, the bank’s perspective in financing trade transactions and collateralizing goods should be described in detail. For instance, financing goods loaded on a vessel when bills of lading are issued to bank’s order provide bank seniority on goods subject to financing since bills of lading are legal and negotiable instruments. When goods arrive at the discharge port and are stored in warehouses, local laws and regulations become an issue because ownership of goods in the warehouses and releases from warehouses are usually subject to local laws and regulations. On the other hand, once goods are stored in warehouses and then sales are affected from warehouse to final buyers, thus the bank’s control over the goods becomes
