In a sample of bank loans to small firms we find a positive relation between the bank's monitoring effort and the loan's interest rate. We also observe an inverse relation between the closeness of banking relationships and interest rates. Further, we see that banks less frequently monitor firms with whom they have closer relationships. We conclude that banking relationships are valuable because firms can significantly reduce their costs of capital by establishing and maintaining close ties to a particular bank. As firms successfully complete loan transactions with banks, banks monitor them less frequently and, ultimately, charge them lower interest rates.

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Window dressing, preferred habitat,

This paper addresses whether Federal Reserve Board accounting requirements are sufficiently pervasive to create regularities in government overnight repurchase agreement (repo) rates. US bank settlement regulations allow overnight government repos as substitutes for Federal (Fed) funds. We find that overnight government repos exhibit rate changes and variance regularities consistent with regularities identified in the Fed funds market, which have been shown to result directly from the Federal Reserve regulations and accounting policies governing the US bank settlement process. Thus, we conclude that the overnight government repo rates are influenced in a similar manner by regulatory rules. However, since the rate changes are not large economically, the influence of regulatory accounting practices does not violate the premise of an efficient market. Copyright Blackwell Publishers Ltd 1997.