Multiple-bank lending: Diversification and free-riding in monitoring

Abstract

This paper analyzes banks' choice between lending to firms individually and sharing lending with other banks, when firms and banks are subject to moral hazard and monitoring is essential. Multiple-bank lending is optimal whenever the benefit of greater diversification in terms of higher monitoring dominates the costs of free-riding and duplication of efforts. The model predicts a greater use of multiple-bank lending when banks are small relative to investment projects, firms are less profitable, and poor financial integration, regulation and inefficient judicial systems increase monitoring costs. These results are consistent with empirical observations concerning small business lending and loan syndication. JEL classification: D82; G21; G32 Keywords: individual-bank lending, multiple-bank lending, monitoring, diversification, free-riding problem Recent empirical findings (e.g., Ongena and Smith, 2000a;Ongena and Smith, 2000b) suggest a widespread use of multiple-bank lending. In almost all countries even relatively small firms borrow from several banks at the same time. The distribution * We thank Franklin Allen, Steven Ongena and Rafael Repullo for comments and suggestions, and seminar participants at the Sveriges Riksbank, Norges Bank, University of Salerno, Università Cattolica in Milan, and European Economic Association Meetings in Stockholm. We also appreciated the excellent research assistance by Diego Fantini. Financial support from MURST ex-60% 2001 is gratefully acknowledged. The views expressed in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Executive Board of Sveriges Riksbank. We are responsible for all remaining errors.

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