Information Production from Individual Saving Behavior and Relationship Lending

Abstract

We develop a multi-period partial equilibrium model of relationship lending that is based on information production in preceding saving relationships. We argue that individuals’ saving behavior is substantially driven by the same characteristic as their debt service behavior, namely the ability to regularly abstain from consumption. The model shows that savings-linked relationship lending is irrelevant in markets of high time preference and also high average borrower quality. Savings-linked relationship lending, however, generally is an equilibrium choice in markets of low time preference or in markets of low average borrower quality. In these markets, savings-linked relationship lending leads to a Pareto improvement or an increasing allocative efficiency of the financing market compared to arm’s-length lending. It is also shown that savings-linked relationship lending is robust to changes in financing volume and can therefore overcome market failure especially for large volume financing. This property makes savings-linked relationship lending well suited for housing finance of private households.The model can be applied to contractual saving for housing (CSH), which is a commonly and successfully used product of housing finance in some Continental European economies. CSH contractually combines a saving relationship with a successive loan. Our model is, to our knowledge, the first to give a theoretical relationship lending explanation for contractual saving for housing. On the basis of our results, policy implications are derived that can support current discussions and policy decisions regarding CSH.