However, other studies suggest that bank size does not necessarily need to decrease small business lending. For example, Strahan and Weston (1998) examined the effects of bank M&A on small business lending, and found that the M&A between small banks increased lending to small enterprises. Even though China has not experienced M&A, a similar phenomenon is the reduction of local branches during the covered sample period; hence, the bank size of local branches may not have a definite impact on small business lending. Berger, Rosen, and Udell (2001) studied the relationship between lending to SMEs and banks’ share of the local loan market. They found that the share of small business lending is roughly in proportion to small banks’ loan market share. Such phenomenon motivates us to study small business lending in China from the perspective of competition in terms of loan market structure.
A study that is of particular relevance to China is that of Berger and DeYoung (2001). They found that it is difficult for bank holding companies to control the efficiency of small banks located at a significant distance from their headquarters. This is consistent with the possibility that relationship lending may be difficult to operate from afar. As China’s financial system is dominated by four main state-owned banks and the headquarters are quite far from county-level local banks, the efficiency of small banks in making small business loans needs careful investigation. In addition to physical distance, other measures of distance can be hierarchical levels of the banks, and the loan approval rights that the local branches possess. If there are more layers between the headquarters and the local branches, relationship lending will be more difficult. On the other hand, if the local bank has 100% self-loan approval right, its physical distance from its headquarters and the bank hierarchical level are less important. China’s financial system provides enough variation in loan approval rights to study its impact on small business lending.
Berger, Klapper, and Udell (2001) also raised the distressed-bank barriers hypothesis. That is, banks in financial distress are less likely to lend to small businesses. Such negative effect will be exemplified if financial distress is directly linked to the income of loan managers because the risks of these loans cannot be easily verified. Researchers also tested whether tougher supervisory standards in examining bank portfolios will decrease relationship lending. While conclusions were mixed, they generally found that tougher standards decrease small business lending. Whether such an observation applies to China, however, remains an open question.