Question

Why is bank lending to large corporations more difficult than making loans to small or mid-size firms? What additional factors are involved? Do banks have some additional tools to help in assessing credit risk of large firms? What are some examples?

Answer 1

Bank lending to large firms are slightly riskier because of the size of loan being given to them. The loan size of small firms are considerably small in size because of their capital requirement is such and any bank limits the amount being given to them whereas in the case of large corporate the size of their loans are considerably huge and if their project did not go well as expected they might default and it can create serious financial consequences for the bank. Another factor is the size of the project and gestation period, the period between the investment is made and the cash flow starts coming in, if the project cash inflow starts after a gap then the risk also increases. Banks do use many tools to evaluate the project viability, current credit standing, current level of debt, current cash position and the overall character and past track record of the management. The banks besides these factors they also consider using debt covenants or having collateral for the loan so that the probability of default reduces. Another way banks try to reduce the risk of such large loans is instead of one bank giving large sum they join a syndicate where a group of bank are financing the project and risk is reduced for the one bank.