Rules versus Discretion in Loan Rate Setting ++ + Geraldo - - PowerPoint PPT Presentation

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Rules versus Discretion in Loan Rate Setting ++ + Geraldo - - PowerPoint PPT Presentation

May 03, 2023 241 likes •473 views

Rules versus Discretion in Loan Rate Setting ++ + Geraldo Cerqueiro Hans Degryse ++ Steven Ongena + Geraldo Cerqueiro Hans Degryse Steven Ongena CentER Tilburg University CentER Tilburg University K.U. Leuven and CESifo CESifo

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SLIDE 1

Rules versus Discretion in Loan Rate Setting

Geraldo Cerqueiro Geraldo Cerqueiro Hans Degryse Hans Degryse++

++

Steven Ongena Steven Ongena+

+

CentER CentER – – Tilburg University Tilburg University

++ ++K.U. Leuven and

K.U. Leuven and CESifo CESifo

+ +CEPR

CEPR

7 7th

th

Annual Bank Research Conference on Liquidity & Liquidity Risk Annual Bank Research Conference on Liquidity & Liquidity Risk Arlington VA, 9/21/2007 Arlington VA, 9/21/2007

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SLIDE 2

Who makes the credit decisions?

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SLIDE 3

The Role of Technology in Banking

«The solution ( «The solution (LiquidCredit Bank2Business LiquidCredit Bank2Business) ) also provides a risk also provides a risk-

  • based pricing matrix.

based pricing matrix. Having an objective, suggested price is very Having an objective, suggested price is very helpful» helpful»

Tina Reisedge*, 2003 Tina Reisedge*, 2003

*Small Business Product Manager of First Tennessee Bank *Small Business Product Manager of First Tennessee Bank

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SLIDE 4

“Rules” vs. “Discretion”

Loan Rates “Discretion” “Rules”

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SLIDE 5

Loan Pricing Models and R2

Study Study R R2

2

# Var. # Var. # Obs. # Obs.

Petersen & Rajan, JF 1994 Petersen & Rajan, JF 1994 0.15 0.15 32 32 1,389 1,389 Berger & Udell, JB 1995 Berger & Udell, JB 1995 0.10 0.10 22 22 371 371 Brick & Palia, JFI 2007 Brick & Palia, JFI 2007 0.11 0.11 80 80 766 766 Degryse & Ongena, JF 2005 Degryse & Ongena, JF 2005 0.22 0.22 83 83 15,044 15,044

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SLIDE 6

Heterogeneity in Pricing Models

  • Sample split regressions (by loan size)

Sample split regressions (by loan size)

– – Degryse & Ongena (JF 2005) Degryse & Ongena (JF 2005)

Loan Size ($) Loan Size ($) # Obs. # Obs. R R2

2

< 5,000 < 5,000 5,850 5,850 0.01 0.01 > 50,000 > 50,000 1,850 1,850 0.67 0.67

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SLIDE 7

Methodology and Main Results

  • Our methodological approach:

Our methodological approach:

– – Variance analysis of unexplained component of Variance analysis of unexplained component of loan rates (heteroscedastic regression model) loan rates (heteroscedastic regression model)

  • Our main findings:

Our main findings:

– – The importance of “discretion” decreases with: The importance of “discretion” decreases with:

  • Loan size (

Loan size (Information search costs Information search costs) )

– – And increases with: And increases with:

  • Borrower opaqueness (

Borrower opaqueness (Switching costs Switching costs) )

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SLIDE 8

Econometric Model

  • Heteroscedastic regression model:

Heteroscedastic regression model:

Mean equation: Mean equation:

y yi

i

= = β β' 'X Xi

i

+ u + ui

i

Variance equation: Variance equation:

σ σi

i

= exp( = exp(γ γ‘ ‘Z Zi

i

) )

  • Extreme cases:

Extreme cases:

– – “Rules”: R “Rules”: R2

2

  • f mean equation → 1
  • f mean equation → 1

– – “Discretion”: R “Discretion”: R2

2

  • f mean equation → 0
  • f mean equation → 0
  • Parameter of interest:

Parameter of interest: γ γ

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SLIDE 9

Hypothetical Example

Loan Rate Loan Size

“Rules”

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SLIDE 10

Hypothetical Example

Loan Rate Loan Size

“Discretion”

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SLIDE 11

Hypothetical Example

Loan Rate Loan Size

β<0 γ<0

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SLIDE 12

Relation Between β and γ

Loan Rate Loan Size

β<0 γ<0

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SLIDE 13

Relation Between β and γ

Loan Rate Loan Size

β<0 γ<0

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SLIDE 14

Data and Variables in Mean Equation

  • Datasets:

Datasets:

– – 1993, 1998 and 2003 SSBF 1993, 1998 and 2003 SSBF – – Belgian sample in Degryse & Ongena (JF 2005) Belgian sample in Degryse & Ongena (JF 2005)

  • In the mean equation we control for:

In the mean equation we control for:

– – Underlying cost of capital Underlying cost of capital – – Loan characteristics Loan characteristics – – Firm/Owner characteristics Firm/Owner characteristics – – Relationship characteristics Relationship characteristics – – Competition / Location measures Competition / Location measures – – Type of lender Type of lender

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SLIDE 15

Mean Equation

  • Number of predictors: 62

Number of predictors: 62

  • R

R2

2 of mean equation: 25%

  • f mean equation: 25%
  • Robustness checks:

Robustness checks:

– – Model specification Model specification – – Discontinuous “Rules” Discontinuous “Rules” – – Relevance of information Relevance of information – – Industry heterogeneity Industry heterogeneity – – Bank heterogeneity Bank heterogeneity

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SLIDE 16

Variables in Variance Equation

  • “

“Discretion” is a product of market imperfections: Discretion” is a product of market imperfections:

– – Information search costs Information search costs Stigler (JPE 1961)

Stigler (JPE 1961)

– – Information asymmetries Information asymmetries von Thadden (FRL 2004)

von Thadden (FRL 2004)

  • Firm opaqueness

Firm opaqueness Petersen & Rajan (QJE 1995)

Petersen & Rajan (QJE 1995)

  • Strength of firm

Strength of firm-

  • bank relationsip

bank relationsip Petersen & Rajan (JF

Petersen & Rajan (JF 1994), Berger & Udell (JB 1995) 1994), Berger & Udell (JB 1995)

  • Firm switching costs

Firm switching costs Bester (AER 1993)

Bester (AER 1993)

– – Competitive structure of banking markets Competitive structure of banking markets

  • Market concentration

Market concentration Hannan (JBF 1991, RIO 1997)

Hannan (JBF 1991, RIO 1997)

  • Firm

Firm-

  • bank distance

bank distance Hauswald & Marquez (RFS, 2005)

Hauswald & Marquez (RFS, 2005)

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SLIDE 17

Results of Variance Equation

Variable γ S.e. (γ)

Ln(Loan Amount)

  • 0.27 ***

0.02 Loan is Collateralized (0/1)

  • 0.18 **

0.08 Firm is a Corporation (0/1)

  • 0.24 ***

0.09 Ln(Age of the Firm’s Owner) 0.39 *** 0.13 Firm Owned by Minority Group (0/1) 0.34 *** 0.13 Firm Has Clean Legal Record (0/1)

  • 0.25 ***

0.09 Firm Had IRS Problem (0/1) 0.16 ** 0.07 Duration of Firm-Bank Relationship

  • 0.12 **

0.05 Concentrated Banking Market (0/1) 0.10 0.08 Firm Located in MSA (0/1) 0.18 ** 0.09 Ln(Firm-Bank Distance) 0.10 *** 0.02 Number of observations 1,425

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SLIDE 18

Information Search Costs

Variable γ S.e. (γ)

Ln(Loan Amount)

  • 0.27 ***

0.02 Loan is Collateralized (0/1)

  • 0.18 **

0.08 Firm is a Corporation (0/1)

  • 0.24 ***

0.09 Ln(Age of the Firm’s Owner) 0.39 *** 0.13 Firm Owned by Minority Group (0/1) 0.34 *** 0.13 Firm Has Clean Legal Record (0/1)

  • 0.25 ***

0.09 Firm Had IRS Problem (0/1) 0.16 ** 0.07 Duration of Firm-Bank Relationship

  • 0.12 **

0.05 Concentrated Banking Market (0/1) 0.10 0.08 Firm Located in MSA (0/1) 0.18 ** 0.09 Ln(Firm-Bank Distance) 0.10 *** 0.02 Number of observations 1,425

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SLIDE 19

Firm Opaqueness / Switching Costs

Variable γ S.e. (γ)

Ln(Loan Amount)

  • 0.27 ***

0.02 Loan is Collateralized (0/1)

  • 0.18 **

0.08 Firm is a Corporation (0/1)

  • 0.24 ***

0.09 Ln(Age of the Firm’s Owner) 0.39 *** 0.13 Firm Owned by Minority Group (0/1) 0.34 *** 0.13 Firm Has Clean Legal Record (0/1)

  • 0.25 ***

0.09 Firm Had IRS Problem 0.16 ** 0.07 Duration of Firm-Bank Relationship

  • 0.12 **

0.05 Concentrated Banking Market (0/1) 0.10 0.08 Firm Located in MSA (0/1) 0.18 ** 0.09 Ln(Firm-Bank Distance) 0.10 *** 0.02 Number of observations 1,425

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SLIDE 20

Economic Significance

Variable Loan A Loan B

Loan Size ($) $25,000 $550,000 Loan is Collateralized (0/1) No Yes Firm is a Coporation (0/1) No Yes Firm Has Clean Legal Record (0/1) No Yes Duration of Relationship (years) 3 13 Predicted Loan Rate (%) 9.3 8.1 Confidence Interval (95%) [5.1–13.5] [6.3–9.9] Predicted R2 of Mean Equation 0.01 0.81

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SLIDE 21

Has “Discretion” Varied Over Time?

  • Empirical Test:

Empirical Test:

– – Sample: 1993, 1998 and 2003 SSBF Sample: 1993, 1998 and 2003 SSBF – – Include in variance equation a time trend and Include in variance equation a time trend and interaction terms interaction terms

  • Results:

Results:

– – Discretion decreased for small loans to opaque Discretion decreased for small loans to opaque businesses businesses Berger, Frame & Miller, (JMCB 2005)

Berger, Frame & Miller, (JMCB 2005)

– – Evidence of risk Evidence of risk-

  • shifting behavior

shifting behavior Rajan (EFM 2006)

Rajan (EFM 2006)

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SLIDE 22

Conclusions

  • Heteroscedastic model identifies determinants of

Heteroscedastic model identifies determinants of unexplained dispersion of loan rates (“discretion”) unexplained dispersion of loan rates (“discretion”)

  • “Discretion” increases with...

“Discretion” increases with...

– – Borrower opaqueness ( Borrower opaqueness (Switching costs Switching costs) )

  • and decreases with...

and decreases with...

– – Loan size ( Loan size (Information search costs Information search costs) )

  • “Discretion” has decreased over the last 15 years

“Discretion” has decreased over the last 15 years for small loans to opaque firms for small loans to opaque firms