Bank Size, Functional Distance and loss given default of bank loans

ost of the studies available on relationship lending focuses on the benefits for borrowers and neglects those achievable for banks. In particular, empirical studies on the benefits achieved for banks in terms of loans recovery rate, in connection with loss given default rate, are very few. In contrast, choosing the best approach to managing loans is crucial in the current credit market considering the high deterioration in quality of bank loans. This paper empirically tests whether the banks more oriented towards a relationship lending approach report a lower level of loss given default. Bank size and functional distance are used to measure the relationship lending approach in banks. This paper takes into account the Italian banking system and the effectiveness of their debt recovery processes during the 2005-2008 period. The data has been collected by ABI Banking Data and Bank of Italy. The empirical analysis highlights that banks more oriented in the relationship lending model have a greater capacity to recover bad loans. These findings have some managerial implications. Keywords: Loss given default, Relationship lending, Bank size, Functional distance 1. Introduction Recently, academics and practitioners focus on best practices on lending technology useful to better monitoring and contrast the deterioration of the quality of banks loan portfolios. Choosing the best approach in credit relationship becomes, in fact, strategically relevant for banks also due to the recent international financial crisis. In literature, most of the studies investigate the benefits of the lending technology for the borrower (Peterson and Rajan, 1994; Berger and Udell, 1995, Berger and Black, 2010), while studies relating to the advantages for the bank, in particular, in terms of improvement of the loss given default rate, are still few and conflicting. The aim of this study is to empirically verify whether the banks more oriented towards a relationship lending approach report a lower level of loss given default. The originality of this analysis is linked to both the nature of the relation investigated and to the measurements adopted, such as intensity proxies of bank relationship lending. In fact, the bank to customer geographical proximity element, essential in competitive organizations based on the value of the relation, is adopted in the analysis to identify any possible improvements in the quality of lending descending from the local market served. In theory, the loss given default rate depends on three main factors: the characteristics of the lending relationship and the implicit components of the contract (collaterals); the effectiveness of the banking structure deputy to loans recovery; macroeconomic factors. Focusing only on the first aspect, the link existing between loss given default rate has been analyzed only in a few works (inter alia, Mattarocci and Gibilaro, 2009). Asarnow and Marker (1995) underline how the time factor in corporate bankruptcy is a crucial factor for the management of LGDR. Thanks to soft information, a close Published by Sciedu Press