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Yannis Cabossioras, "Bank Specialization and Holdup Behavior: Evidence and Real Effects From Small Business Lending in Belgium."

Yannis Cabossioras is a sixth-year Ph.D. candidate in Finance at NYU Stern. His research lies at the intersection of banking and industrial organization. He explores how banks make lending decisions to firms and investigates the broader economic impacts of imperfections in the corporate credit market.

Research Summary: My research project studies the market for corporate credit and investigates whether banks take advantage of their borrowers in the industries they specialize in.

Borrowers and lenders tend to form long-lasting credit relationships. Repeated interactions between lenders and borrowers reduces adverse selection and are often seen as mutually beneficial; as lenders learn about the quality of their borrowers, they are can offer them better credit terms. However, the benefits of these arrangements may vary over time. As theorized by Sharpe (1990) and Rajan (1992), borrowers wanting to break away from their relationship may face worse credit conditions since outside lenders would demand compensation for the risk of lending to new borrowers. Such switching costs are expected to become increasingly salient over the course of a relationship, allowing lenders to "holdup" their borrowers by charging higher rates.

In reality, borrowers and lenders are heterogenous; some firms are more attractive borrowers, and certain banks may have advantages in forming relationships, particularly within specific industries. Banks might prefer to focus on certain sectors when acquiring information about borrowers is costly or if they are able to gain market share by offering differentiated products. Thanks to its comparative advantage, a bank specialized in given industry should attract the best borrowers by offering them more favorable credit conditions at the start of their relationship. As their relationship progresses, a specialized bank is expected to extract more surplus from its borrowers compared to a bank holding a diversified portfolio weight in that industry.

The previous intuition is verified in the data. I use contract-level administrative data on the universe of corporate credit in Belgium from the National Bank of Belgium to show that banks do exert stronger holdup on the borrowers belonging to industries they specialize in. Specialized lenders offer a 17 basis point discount on rates at the beginning of a relationship compared to diversified lenders. As the relationship develops, specialized lenders increase their rates faster than diversified lenders; charging higher rates after seven years.

The joint study of credit relationships and banks specialization offers new insights on the benefits of relationship lending. Banks leverage their knowledge about the industry they specialize in to cross-subsidize credit for younger, riskier firms by extracting more surplus from safer borrowers with whom they have established relationships.