The institutional environment and the number of bank relationships: An empirical analysis of European SMEs

This article examines the association between creditor protection, as measured by the nature of legal rules and the quality of law enforcement, and multiple bank relationships using a unique survey sample of SMEs from 19 European countries. We find that the likelihood of multiple banking is the highest for SMEs in French-civil-law countries, next highest for German-civil-law countries, and the lowest in Scandinavian-civil-law and English-common-law countries. We also find that SMEs in countries with low legal efficiency are more likely to establish multiple bank relationships. These results seems to confirm the underlying idea in the law and finance literature that relevant loan risk for banks also arises from low quality of laws and institutions and not just from firm-specific characteristics. Banks in countries where protection of creditor rights is poor may resort to multiple banking to share this additional risk. Policy makers can use our findings to justify the necessity of improving their institutions by reducing legal formalisms and thereby, lowering the enforcement costs in the courts. This would lead to better loan contracting and enhance the flow of debt capital, which is required for a healthy and dynamic economy. © The Author(s) 2008