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Working Paper

Relationship Loans and Information Exploitability in a Competitive Market: Loan Commitments vs. Spot Loans

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Despite the numerous benefits of loan commitments, only 79% of the commercial and industrial loans are made under commitment. I show that two factors limit the use of loan commitments. First, because banks commit themselves to lend, they carry costly liquidity reserves to meet their obligations. Due to liquidity costs, the interest rate on commitment loans is high relative to spot loans. Second, high interest rates trigger moral hazard. If the bank expects a profitable relationship in the future, it can absorb a portion of the liquidity costs to reduce the interest rate and attenuate moral hazard. If not, the borrower cannot get a loan commitment.
11.01.2000ISSN 2573-7953 WP 00-13DOI 10.26509/frbc-wp-200013
Keywords loan commitments, relationship loans, information exploitability, loan maturity
JEL Classification Codes G21, D45

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.

Suggested Citation

Ergungor, O. Emre. 2000. “Relationship Loans and Information Exploitability in a Competitive Market: Loan Commitments vs. Spot Loans.” Federal Reserve Bank of Cleveland, Working Paper No. 00-13. https://doi.org/10.26509/frbc-wp-200013