Banking relationships: A solution for family firms?

Financing is an essential issue for all businesses, and even more so for family firms. However, several studies have analysed whether or not family firms have easier access to bank credit, and the results are rather mixed. 

On the one hand, the efficiency-based theory explains that family firms are perceived as having a comparative advantage. Family owners tend to have a longer term view than others, thanks to the transmission of the business from one generation to the next. This long-term view brings a certain stability, reducing the likelihood of company default, as well as an opportunity for long-term investments, enabling greater profitability, all of which increases the probability to obtain a credit line. 

However, on the other hand, cultural theory explains that in family businesses, the owners will want to maximise the family profit rather than that of the company, resulting in an increased risk of default, hence a restriction of credit. So, what is the reality? Recent studies tend to show that there’s no difference in terms of credit constrained when we compare family firm to non-family firm. Nevertheless, when we go deeper in this analysis, these analysis, these results do not appear to consider the size. Indeed, small ones tend to be on average more constrained than others when it comes to accessing external credit financing. For example, in Italy, family businesses are 1.7% more rationed than others. 

To understand the potential solutions to this situation, we must first understand that granting credit is not a simple and single mechanism. In fact, there are two main granting mechanisms: relationship banking and transactional banking. Relationship banking involves the bank's specialisation in the acquisition of soft information, also called qualitative information (for example, ideas, opinions, long-term projections, informal information etc). These banks rely on a long-term relationship, enabling them to analyse all this information in the best possible way. In contrast, transactional banking is based on the bank's collection of hard information, also seen as quantitative information (e.g., balance sheets and income statements for a company). It's a "one-shot" loan that doesn't require a long-term relationship but favours pure transaction rather than customer knowledge. 

What does this mean for customers? 
Let's take two small companies that are identical from a quantitative point of view, so they have roughly the same net income and the same ratios. These firms are in complicated economic situations, leading to a depreciation in the quality of their quantitative information. However, one is a family business, while the other is a traditional company. 

If both companies go to a transactional bank, the probability of obtaining a loan will be relatively low. Indeed, as their hard information is not of good quality, they will be perceived as having a high chance of defaulting and, therefore, will not obtain credit or only at a high rate. 

If the same two companies now go to a relationship bank, this bank will consider not only hard information, but also soft information. Soft information works in favour of family businesses. Indeed, family firms by nature possess more soft information, giving them an advantage. It is in the nature of family firms to create relationships. Indeed, their generational structure favours the development of long-term relationships, and thus the exchange of soft information. This advantage will be taken into account when valuing the firm, and will therefore increase their likelihood of granting credit. 

Where can we find relationship banking? 
One question we can now ask ourselves is how to recognise a relationship bank. If we now know that family firms benefit from this relationship, it's important that they have access to it. Soft information is by its very nature qualitative, and difficult to pass on from one person to another. This means that, to make the best use of it, the person who accumulates it - the business manager - must be able to exploit it, and therefore be the decision-maker when it comes to granting credit. Relationship banks are predominantly small banks and so-called local banks, i.e. only present in certain regions or departments, where there is little or no national organisation. 

Jérémie Bertrand is Professor and Deputy Academic Director of the Grande École Program at the IÉSEG School of Management. He holds a Ph.D. in Management Science from the University of Lille, specialising in finance, and his research interests include the relationship between banks and their customers (relationship banking), the consequences of trust for banks, and the impact of the psychology of individuals on their financial decisions.