Question

Why is bank lending to large corporations more difficult than making loans to small firms? What additional factors are involved in this process? 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 corporations is more difficult as large corporations have access to the corporate debt market from where they can raise large amount of money at a competitive cost and hence can lower their cost of capital. So banks have to maintain their competitiveness with the bond yields while trying to lend to large corporations.

Moreover banks would want some collaterals for the loans that they are advancing and many large corporations would not want any lien on their assets and hence would refuse such collaterals and thus making the loans to large corporations more risky and even more difficult.

Additional risk factors would be:-

1) Large amount of debt funding required

2) Minimal collateral available

3) Risk adjusted returns not commensurate enough for banks

4) Sector concentration while lending to large corporations in a similar industry.

The additional tools that banks have to assess credit risks are:-

1) Use of credit ratings provided by agencies

2) Availability of working capital for the firm's to which loan is advanced

3) Past credit history

4) Reputation of the company to which loan is being made

5) Financial strength of the majoirty shareholders, if any.