Introduction

The term relationship banking or relationship-based banking is often used to mean connection-based banking, which constitutes the core of the "crony capitalism" that many allege brought about the Asian crisis of 1997. The crisis clearly demonstrated the potential traps of relationship banking. However, relationship banking has many advantages as well. First of all, it allows banks to make the best use of their comparative advantages versus the public debt market. Banks usually repeat transactions across different financial services, allowing economies of scale and scope in information production as well as reputation building for both parties, which can be an essential factor for loan negotiations or other financial transactions in a world of incomplete contracts. Relationship banking may be seen as nothing more than the banking practices designed to maximize these advantages.

Second, the reason why we are particularly interested in relationship banking in Asia is because of its potential role in corporate governance. Asian enterprises are predominantly family-based, even the largest business groups. Given the management control by family owners, corporate governance has typically been poor. Family owners have tended to oppose the introduction of proper corporate governance mechanisms, which would constrain their pursuance of family interests often at the expense of minority shareholders. The consequent expropriation of minority shareholders has been a serious problem, as it represents gross misallocation of corporate resources in addition to being unfair and detrimental to capital market development.

It has been widely believed that the misguided resource allocation and poor corporate investment performance were largely responsible for the Asian crisis. It is not surprising that the post-crisis reform package put high priority on improving the corporate governance system. The emphasis has been placed on strengthening the basic infrastructure for sound corporate governance, such as accounting, audit and disclosure practices. Concerning specific corporate governance mechanisms, however, the major focus has been placed on Anglo-American type systems: strengthening minority shareholder rights, improving the workings of the board of directors, and fostering the market for corporate control. Although reforms along these lines are no doubt needed, it is doubtful whether this model will work efficiently in these economies. The efficacy of the model has been much debated even in the Anglo-American countries, where the relevant capital market institutions supporting the system are relatively well established. Given the much smaller institutional requirement for bank-based corporate governance, it is rather surprising that the role of banks has not been much emphasized in corporate governance reform in the Asian economies.

Given the high debt leverage in corporations in the crisis-hit Asian economies and the disciplinary role of debt, banks are potentially in a strong position to monitor and control the management of client firms. In reality, however, banks have failed to play any meaningful corporate governance role in these economies due largely to poor corporate governance in the banks themselves. In Indonesia, banks were dominated by the state and private banks controlled by businesses and politicians, leading to collusion and corruption between political elite and big businesses. In Thailand, family-controlled banks were heavily involved in connected lending, even though the state and bureaucrats were less involved in the banking and big businesses. In Korea, big businesses were for the most part prohibited from owning and controlling the major banks. However, the consequent diffuse ownership structure of banks created a vacuum of corporate governance and the government continued to control and intervene in the management of the privatized banks.

As the result of recapitalization and other restructuring measures, the power of families is today much weaker in the banking sector of Thailand and Indonesia, and many countries are concerned with improving the corporate governance of banks. As the banks are reborn with adequate capital, healthy asset portfolios and sound corporate governance, they should be in a position to be more serious about relationship banking, and to avoid the many perils associated with the practice.

This paper, on the basis of a review of the theoretical and empirical literature on relationship banking, attempts to identify the main constraints to fostering healthy relationship banking, in order to enable banks to more effectively monitor their clients. Also presented is the result of a questionnaire survey of the major Korean banks to evaluate the perceptions of bank officers on relationship banking and bank governance. Section 2 describes the concept and nature of relationship banking together with its merits and demerits. Section 3 is devoted to anatomizing the empirical aspects of relationship banking, including credit availability and liquidity constraints, risk-sharing, assistance and intervention in times of corporate distress, as well as the effects on firm performance. Section 4 discusses the major constraints to banks’ monitoring and disciplining of the management of corporate clients. The survey results on the perceptions of Korean bank officers on relationship banking and bank governance are presented in Section 5. Finally, Section 6 provides brief conclusions.

The views expressed in this paper are the views of the author/s and do not necessarily reflect the views or policies of the Asian Development Bank Institute nor the Asian Development Bank. Names of countries or economies mentioned are chosen by the author/s, in the exercise of his/her/their academic freedom, and the Institute is in no way responsible for such usage.

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