Loss of a lending relationship: shock or relief?

ENWe use loan-level data and a novel identification setting - closures of banks - to study how forced break-ups of lending relationships affect firms’ borrowing costs. We find that after a financially distressed bank closed and its best borrowers were exogenously forced to switch, their borrowing costs dropped steeply and converged to the market’s average. We document no such effect when a healthy bank closed. This suggests that distressed banks can use informational monopoly power to hold up and exploit their best borrowers. Apparently, closures of such banks can release the best-quality firms from the hold-up and allow borrowing cheaper elsewhere. Keywords: relationship lending, hold-up, asymmetric information, bank closures, financial distress, switching costs. [From the publication]