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The Impact of Organizational Structure & Lending Technology on Banking Competition. Hans Degryse CentER - Tilburg University, TILEC, K.U. Leuven & CESIfo TILEC-AFM Chair on Financial Market Regulation Luc Laeven IMF & CEPR Steven Ongena CentER - Tilburg University, TILEC & CEPR
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The Impact ofOrganizational Structure & Lending Technology on Banking Competition Hans Degryse CentER - Tilburg University, TILEC, K.U. Leuven & CESIfo TILEC-AFM Chair on Financial Market Regulation Luc Laeven IMF & CEPR Steven Ongena CentER - Tilburg University, TILEC & CEPR Con ference on ”The Changing Geography of Banking”, Ancona, September 2006
Motivation: Bank Organization & Spatial Pricing • Bank’s internal organization matters for lending Stein (JF 2002); Takats (ECB 2004); Liberti (2004); Liberti & Mian (2005), Berger et al. (JFE 2005) • Opaque (small) firms borrow from close banks Petersen & Rajan (JF 2002); Saunders & Allen (2002) • Large, centralized banks lend to distant, large firms using hard information Berger, Miller, Petersen, Rajan & Stein (JFE 2005); Cole, Goldberg & White (JFQA 2004) • Banks spatially price loans Petersen & Rajan (JF 2002); Degryse & Ongena (JF 2005); Bharath, Dahiya, Saunders & Srinivasan (JFE 2006), Agarwal & Hauswald (2006) Bank’s internal organization matters for branch reach and spatial pricing of loans Also rival banks’organization matters This paper!
“Objective” Information “Travels Better” than “Subjective” Information Transportation Costs Differ: “Number of visits” or “mode of communication” By borrower to bank By bank to borrower may differ if banks’ organization implies different types of information Subjective or Soft information: more visits Objective or Hard information: fewer or no visits
Transportation Cost Model: stylized version with linear transportation costs • Banks A, B located at endpoints of line (length 1) • Transportation costs tiper unit of distance, shaped by internal organization of bank i • Consider borrower at location x • Cost visiting A: tAx • Cost visiting B: tB(1-x) • Cost taking loan at A: rAx + tAx • Cost taking loan at B: rBx + tB(1-x)
Equal Linear Transportation Costs Now introduction different costs, but for graphical purposes, we assume tA= t. Loan Rate t -2t MC = 0 0 1/2 1 Bank A Bank B Distance
Drop in tB (e.g., B employs more objective information):A’s reach shrinks and spatial pricing becomes softer Loan Rate tA tB tA+ tB - (tA+ tB) MC = 0 0 1/2 tB / (tA+ tB) 1 Bank A Bank B Distance
In the paper, we also model: • Non-Linear transportation costs • Banks with different marginal costs • “Soft Firm – Hard Firm” and “Soft Bank – Hard Bank” • “Soft firms” generate more soft information • If bank A has a comparative advantage in soft information: • Bank A’s reach decreases when B becomes “harder” • But less so for “soft firms”
Data: We combine two data sets 1 Portfolio from one Belgian bank 17,776 loans to 13,104 borrowers in August 1997 Degryse & Van Cayseele (JFI 2000); Degryse & Ongena (JF 2005) sole proprietorships (81%), small, medium, and large firms • Loan Characteristics • Origination Date, Loan Rate, Collateral, Repayment Duration, Purpose, Other • Relationship Characteristics • Main Bank and Duration • Firm Characteristics and Identity (incl. Address)
Postal Zone 837 Postal Zones; 7,477 Bank Branches Lender also possible Competitors 6 km Borrower 6 km
Distance = shortest traveling time, in minutes • to Lender • to Closest quartile (Bank) Competitor in the borrower’s postal zone 17,776 + 293,170 borrower - bank branch combinations Recording errors; 801 at closing branches; 1% - screen(postal zone check) 612 contracts in postal zones without competitors 15,044 remaining contracts
2 Bank organization variables (source: Belgian Bankers` Association)
Differential Effects & work in progress • Effect of hierarchy on branch reach is smaller for small firms with limited liability • Effect of hierarchy on spatial pricing is larger for small firms with limited liability • Not incorporated in paper yet: • Layers to Telex softens spatial pricing • Span of control: little impact
Conclusions • Simple model shows that: • Branch reach and severity of spatial loan pricing depend on the organization of competing banks • Empirical Tests: • Branch reach shrinks • Rival bank is large, hierarchical, or has fax • Spatial pricing softens • Rival bank is large or hierarchical