Are Firms Constrained By Their Bank? A Pilot Study

Abstract

Financial intermediation theory assigns banks a unique role in the resolution of information asymmetry, while monetary theory assigns banks a unique role in money creation and the of monetary policy. The bank’s willingness to lend depends on perceptions of the project’s payoffs and the moral rectitude of the borrowers, while the bank’s ability to lend depends on the adequacy of the bank’s capital and the stance of monetary policy. Small firms are largely dependent on bank financing - information asymmetry, moral hazard and switching costs restrict access to alternate financing sources. If firms were constrained by their bank’s ability to lend, measures of bank capital would be significant determinants of the firm’s growth. By identifying specific bank-borrower relationships, we explore the hypothesis that a bank’s capital adequacy situation has the potential to influence lending decisions and hence affect the bank’s asset structure and the small firm’s ability to finance operations.