Discussion by Gregory F. Udell Kelley School of Business, Indiana University at the conference on

1. BANKS, DISTANCES AND FINANCING CONSTRAINTS FOR FIRMSbyPietro Alessandrini, Andrea F. Presbitero and Alberto ZazzaroLABIS – Dipartimento di EconomiaUniversita Politecnica delle Marche Discussion by Gregory F. Udell Kelley School of Business, Indiana University at the conference on The Changing Geography of Banking organized by the Department of Economics Università Politecnica delle Marche Ancona, September 22-23, 2006

2. THE CONTEXT • Considerable interest among economists in the uniqueness of bank finance • The extent to which banks can solve information problems • Much attention on relationship lending • Based on soft information about the borrowing firm, the entrepreneur and the local environment • Theoretical argument is compelling • Supported by emphasis in the practitioner community • What commercial lender doesn’t talk about the importance of “relationship building”?

3. THE CONTEXT (cont.) • The existence and the economic importance of relationship lending is still an empirical issue. • Economic theory offers predictions about (among other things) • Who obtains relationship lending (e.g., opaque SMEs) • Who delivers relationship lending (e.g., community banks) • Market conditions conducive to relationship lending (e.g., non-competitive markets) • Its importance during financial distress and banking crises • The nature of contracting under relationship lending • The validity of these predictions has importance policy implications regarding • The financial institutions structure • The lending infrastructure • Optimal “structures” will minimize financing constraints • But, our understanding of relationship lending is still incomplete

4. THE FOCUS OF THIS PAPER • This paper focuses on the essence of relationship lending: the nature of soft information. • At the beginning the empirical literature identified three measures of a bank’s ability to generate soft information • Relationship length • Lender concentration (i.e., multiple banks) • Lender distance • This paper pushes the last concept in a very interesting way

5. FUNCTION VS. OPERATIONAL DISTANCE • This paper adds significantly to the literature by making a distinction between two types of distance 1. Operational distance • Traditional/typical notion of distance • The distance between the borrower and the bank

6. FUNCTION VS. OPERATIONAL DISTANCE 2. Functional distance • The distance between the borrower and loan decision-making • Two alternative measures • The physical distance between the branch and bank headquarters, and (b) The cultural difference between the branch and bank headquarters • Proxied by voter turnout • Captures the organizational issues associated with communication measured within the bank (e.g., Stein 2002, Liberti 2005) and delegation of loan authority (e.g., Udell 1989)

7. THE CONTRIBUTION • It focuses on problems that informational opacity creates within the bank’s organizational structure • Looks deeper empirically into the black box of banking organizations • Gives us an interesting new insight into what is driving these organizational diseconomies • Finds that cultural differences in terms of social capital matter • Permits a more complete examination of the spatial impact of banking industry consolidation • Consolidation affects branch density and organizational form • Some evidence that these may move in opposite directions

8. THE CONTRIBUTION • Somewhat analogous to cross border ownership and efficiency (e.g., Berger et al. 2000) • Cultural differences may matter to efficiency in cross-border banking • Most similar to Liberti and Mian (2006) who look at the usage of soft vs. hard information as the loan decision moves up the hierarchy of the bank • Find that the probability of loan approval is more dependent on hard information at higher levels in the hierarchy • This paper not confined to so a single bank like Liberti and Mian (2006) • (Need to cite this paper) • A very interesting extension!

9. THE PROBLEM OF MEASURINGFINANCING CONSTRAINTS • The dependent variable is financing constraints • A troubling issue for empiricists • The authors do a good job of addressing this issue • Three measures of financing constraints used • Answer to survey question (firm level) • Investment cash flow sensitivity (firm level) • Credit line usage ratio (market level) • They do a good job of addressing the Kaplan and Zingales critique • Financially constrained firms exhibit higher sensitivity

10. SOME ISSUES • This is (mostly) a market-based approach • Key measures of distance are at the market level • Does not measure operational distance between individual borrowers and their individual banks • Does not measure functional distance between individual borrower’s branch and the branch’s headquarters (except with additional dichotomous dummy – see below) • This is different from many papers which measure distance at the firm level (e.g., Berger et al. 2005) • I would like to see more discussion of the pros and cons of using market level vs. “firm level” distance

11. SOME ISSUES (cont.) • I’m a little confused about having both functional distance at the market level (the continuous variable FD) and at the firm level (the dichotomous variable BANK_PR) in the same regression • BANK_PR is dummy = 1 if bank headquartered locally • Authors interpret as a relationship variable • However, conceptually it looks like FD • Statistically negatively correlated with FD • Correlation, however, is low -- as authors point out • Makes the coefficients of FD and BANK_PR somewhat difficult to interpret • May explain the seemingly inconsistent findings on BANK_PR and BANKS • Again, firm level functional distance may be better measure (if available)

12. SOME ISSUES (cont.) • “Firm level” distance would permit an interaction between operational distance and functional distance • Might be good alternative to the interaction of firm size and “market level” functional distance • Might implicitly control for the fact that even some small firms may be transparent and not need relationship lending • Functional distance only matters for operationally close banks where loan officers can collect soft information • Market level calculation on credit cooperatives also somewhat limiting • Findings inconsistent with Angelini et al. (1998) who find that CCBs ration less • Angelini et al. (1998) use firm level data

13. SOME ISSUES (cont.) • Not all SME financing to opaque borrowers is relationship lending (Berger and Udell 2006) • E.g., factoring and leasing may provide substantial financing to opaque SMEs in Italy • Spatial theories of relationship lending may not apply to these types of lending technologies • Factoring and leasing may be doubly problematic • May not be considered when borrowers answer the question about bank rationing • They do not appear on balance sheet • The receivables are removed when factored • The equipment is not on the balance (unless capitalized) when leased • In both cases credit rationing on the balance sheet might offset with this off-balance sheet financing • Difficult to control for

14. SOME ISSUES (cont.) • How much of the organizational diseconomies can differences in social capital as proxied by voter turnout explain? • Social capital: • Advantages and opportunities that accrue to people through membership in certain communities (Bourdieu 1986) • A resource that emerges through social ties (Coleman 1990) • It has explained differences in financial development in the banking sector in Italy (e.g., household use of checks and access to individual credit) (see Guiso et al. 2004) • Here the issue is the agency problem between loan officers and (remote) managers • Social capital would seem at least as equally important here • Is the difference in social capital as important as the level? • Is result robust to alternative measures? • E.g., blood donation rate (Guiso et al. 2004)

15. SOME ISSUES (cont.) • Importance of functional distance may differ significantly across banks • Evidence in U.S. of significant differences across banks in terms of delegation of loan authority (Udell 1989) • Delegation may be determined by functional difference, i.e., more delegation of local lending authority when social capita is high • Bias goes the right way here

16. CONCLUSION • Very interesting paper!!! • The results on functional distance provide very interesting new insight into the organizational issues associated with relationship lending