Borrowing from Suppliers versus Borrowing from Banks

Abstract

To gain a better understanding of the financing motive theories of trade credit, we trace a sample of young firms from their start in 2004 through 2011 and document two main empirical regularities. First, we find that supplier lending is only a supplementary form of financing among these firms, and we do not observe any substitution between supplier lending and bank lending among these young firms during the latest banking crisis from 2007-2009. Second, the overwhelming majority of firms borrowing from suppliers have revolving bank lines that are far from being fully utilized and the unused amount of revolving lines seems sufficient to cover these firms’ borrowing needs. This behavior is likely due to the different lending criteria of suppliers and banks. Suppliers’ lending decisions are primarily driven by a client’s sales, whereas banks’ lending decisions do not seem to be tied to firms’ financial conditions. As a result, availability of trade credit does not help to obtain bank credit. Our findings not only help to explain why supplier lending and bank lending co-exist, but also highlight the critical role that banks play in funding small businesses, which has been largely overlooked in the existing literature.