Unleashing upstream potential: how banks’ downstream lending experience improve upstream borrowers’ performance?

Purpose: Banks often face the decision of whether to extend loans to a supply chain member whose business partner is already a borrower. These banks, which we refer to as downstream lenders because they typically lend to a major customer before the supplier, hold a unique informational advantage. However, relatively little is known about whether and how downstream lenders leverage existing borrower relationships when evaluating loan applications from other firms within the same supply chain, especially underperforming suppliers. This study addresses that gap by investigating whether downstream lenders utilize private information from those existing relationships when assessing the supplier’s credit applications.

Design/methodology/approach: The analysis employs multivariate regression techniques to examine the matching of underperforming suppliers with downstream lenders in the loan market. Additional regression analyses explore differences in subsequent performance between borrowing suppliers that receive loans from downstream lenders and those that do not.

Findings: Underperforming suppliers are more likely to secure loans from downstream lenders. Moreover, suppliers that receive such loans tend to exhibit improved performance in the following year. This finding is robust to pre-treating the observations using the entropy balancing method. Additional evidence suggests that downstream lenders leverage their knowledge of borrowers’ customer relationships to more effectively evaluate investment potential and assess future risks.

Originality/value: These findings underscore the significant role downstream lenders can play in supporting underperforming but promising firms, thereby alleviating financing constraints and enhancing capital allocation efficiency.