Relational Financing as an Institution and its Viability under Competition

This paper presents a new, generic definition of relational financing that may cover a wide range of financial practices in different economies, ranging from the Japanese main bank relationship, to bank lending to smaller firms, and venture capital in the U.S. It then discusses various incentives of the financier to commit to relational financing and reviews the recent literature on issues about how those incentives are affected by increasing competition. One useful insight is that increasing competition is not necessarily harmful to relational financing. It then applies theoretical insights to problems of institutional transition in two Asian economies. It argues that the Japanese financial system will retain some aspects of relational financing even after the impending financial deregulation, although there will be a significant reduction in the bank s role in corporate governance. Finally, it assesses that the ongoing experiment of main bank relationship in China may be one of viable financial options for successful transition of the planned economy to a market economy, but cautions that more competition in the banking sector is necessary for relational banking to emerge as an institution.