Explaining related party transactions in commercial banking: looted lending and information-based investments

David Tennant and Marlon Tracey

Applied Financial Economics, 2013, vol. 23, issue 19, 1509-1530

Abstract: In the context of constrained credit markets, the information view of related party transactions (RPTs) is used to argue that such transactions are efficient, as they make the best use of limited information. The looting view of RPTs is, however, used to make the opposing argument -- during periods of financial distress, bank insiders use their control over lending policies to loot banks. Properly understanding RPTs, minimizing the attendant risks and capitalizing on any extant informational advantages will only be possible when the motivations behind such transactions are investigated. Using dynamic OLS and error correction methodologies, this article examines the conditions under which commercial banks engage in RPTs to ascertain whether evidence can be found for either the looting or information views. The results indicate that the looting and information-based motivations distinctly and separately impact on different types of RPTs, with related party loans (RPLs) being influenced more heavily by looting and related party investments (RPIs) by information efficiencies. The policy implications are significant. Whereas the traditional approach of restricting RPLs seems to be justified, there is a case for encouraging RPIs, particularly in an environment wherein information is fragmented and costly to obtain.

Date: 2013
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DOI: 10.1080/09603107.2013.835476

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