Theory and Hypotheses: The Effects of Using Soft Information on a Lender’s Performance, Specifically in Interbank Competition

Abstract

This chapter provides a survey of recent literature on the utilization and role of soft information in relationship lending, especially as it concerns SMEs in regional markets. Contemporary literature suggests that a complex relationship exists between using soft information and lender performance, although some empirical evidence supports soft information’s positive effect on loan profitability, and convincingly argues that such information effectively functions under greater interbank competition. This chapter summarizes recent theoretical and empirical advancements in literature, and consequently develops hypotheses regarding how such information might prove advantageous to financial institutions in both normal conditions and with interbank competition. First, a highly marginalized lending market creates monopoly rents allowing lenders that strategically collect and use soft information to achieve better lending performance. Second, lenders in competitive local markets can acquire an informational advantage to limit their own losses through relationship lending, although interbank competition negatively affects loan performance. Chapter 4 then tests the authors’ proposed arguments.