Even though there is evidence indicating that large banks lend more money than smaller banks, research has indicated that both banks serve different kinds of borrowers.
Large banks often focus on lending money to well-established borrowers who they are sure would return their money. To decide the same, they take into account the audited financial statements.
On the other hand, it is easier for less-established firms and individuals to borrow money from small banks. What makes the functioning of both the banks different is that small banks consider soft information while lending money.
Relationship-based lending also consists of business group financing, trade credits and even family loans. It is common for many people across the globe to borrow money from someone who has won Lottery Sambad to finance a business or manage other financial things like pursuing education or buying tickets for Dhankesari. Such alternative, relationship-based lending, is typical but, at the same, is risky. The question is, how good is relationship-based lending in the first place?
Better Payoffs For Everyone
In all lending, the ultimate aim of both the lenders and borrowers is to maximise the utility. Therefore, both the lenders and borrowers work in a manner that can manually benefit both. Related-based lending offers intimate information to the lender and helps them understand the purpose of the money and what they can expect from it.
This information makes it easier for the lender to decide on the interest rate. On the other hand, the lender has a clear idea of the amount of effort that needs to go in to return the money with interest. This equation gives rise to competitive financing marketing. Even though the interest of the borrowed money can be the same irrespective of whether it is relationship-based lending or not, there lies a vast difference between them both.
In relationship-based lending, it is common for the borrower to put more effort into a better pay-off.
The Dangers Of Relationship-Based Lending
One of the benefits of relationship-based lending is that the borrowers do not need to worry about the information production costs and loan monitoring costs, especially if one has borrowed money from a single lender. However, the risk associated with it is high too.
Research has indicated that private information provided to such lenders can tempt the lenders to extract more money from the borrower in the long run. They can also use the information available to them as a threat. In a study conducted in Norway and Portugal between the borrower and the lender, banks, in this case, the study, indicated that as the relationship ages, the probability of the relationship ending increases too.
The Necessary Precautions
Everything has its pros and cons, including relationship lending. Therefore, it is essential to take the necessary precautions while engaging in relationship-based lending to ensure that you stay safe. Firstly, comparing the loan rates amongst all the available options is essential. Also, it is crucial to ensure that the lender is able to meet all your money requirements to avoid any additional financial headaches.
If these requirements are met, you can read the fine prints. Reading the fine prints is essential to avoid unexpected ugly situations. Empower yourself with all the conditions regarding the loans. In case of any doubt, enquire about the same to the lender. Only when you understand all the terms and conditions can you go ahead with the negotiation.
Also, it is equally important to know your lender. Research the relationship that the lender has shared with the previous borrower. You must ensure that the lender is credible and will not create unwanted circumstances for you after you borrowed the money. As the name suggests, in relationship-based lending, the relationship is of utmost importance.
Wrap Up
By taking all the necessary precautions, relationship-based lending can be a good option, especially when one is not eligible to borrow money from standardized, big banks or when the requirements are unmet. However, it is first essential to establish a real relationship with the lender before engaging in relationship-based lending. Across the globe, relationship-based lending is common and popular for a reason. Even though the risks are high, the benefits are higher too. To ensure that everything works in one’s favour, all that one needs to ensure is to take calculated risks.