He who lends knows

Abstract

We show that a bank's knowledge of an industry developed through its loan portfolio facilitates the bank's credit provision to other firms in that industry. This effect works beyond the bank's private information about the focal firm and is consistent with a cross information production where experience with other firms from a similar background reduces information asymmetry on the firm concerned. To tackle endogeneity, we develop an instrument for a bank's expertise in an industry based on historical, natural, and regulatory conditions. We provide further evidence using the 2007 housing market crash as a laboratory. We find that banks hit by the shock rebalance loan allocations to buffer borrowers in their expertise industries from a credit crunch. The effect of industry expertise is more pronounced for opaque firms and firms facing foreign competition pressure. Our findings suggest a spillover effect or economies of scale in banks’ information production. It helps explain the cost efficiency of financial intermediaries relative to direct lending and why, beyond relationship considerations, firms may prefer some banks over others.