DP17003 Collateral versus Lending Relationships: shocks to small business credit in the Great Recession
Small businesses can overcome asymmetric information in credit markets using collateral and by forming lending relationships. Differences in whether a small business is predominantly "collateral-dependent" or "relationship-dependent" can lead to a differential impact of different types of credit shocks during recessions. I use novel transaction-level data from a leading online accounting software in the US for a large and representative sample of small businesses, for whom I measure two types of shocks at the firm level: bank insolvencies, and changes in real estate prices at the business owner's residential location. I find that bank insolvencies lead to a substantial decline in firm credit, however the effect is driven by the effects on relationship-dependent firms. In contrast, house price movements significantly affect the credit of collateral-dependent firms as expected, but do not affect the credit of firms that are predominantly dependent on relationships. The analysis thus reveals that credit shocks with different origins can have differential impact within the small business universe, due to heterogeneity in firms' sources of borrowing.