Li Hao Debarshi K. Nandy Gordon S. Roberts Schulich School of Business York University

1. How Bank Regulation, Supervision and Lender Identity Impact Loan Pricing: A Cross- Country Comparison Li Hao Debarshi K. Nandy Gordon S. Roberts Schulich School of Business York University Toronto, Canada

2. Overview • Barth, Nolle, and Rice (1997) document a wide range of banking structures and supervisory practices across countries. • Demirguc-Kunt, Laeven, and Levine (2004) highlight the importance of bank regulation and supervision. • Bank regulation affects net interest margins and overhead costs. • We address how differences in a country’s bank regulation and supervision practices impact financial activities.

3. Research Goals • To examine how differences in a country’s bank regulation and supervision practices impact loan pricing after accounting for the effects of the country’s legal and institutional characteristics. • To investigate whether bank regulation and supervision practices have different impacts on the lending pattern and loan prices of foreign and domestic lenders.

4. Bank regulation and supervision variables • Banking-commerce integration • Banks own non-financial firms • Non-financial firms own banks • Banking concentration • Concentration of assets • Concentration of deposits

5. Law, Institutions and the determinants of Loan Price • Qian and Strahan (2005): • Test how legal and institutional variables affect loan pricing. • Provide evidence that loan contracts reflect differences in investor protection and law enforcement.

6. The determinants of loan price • The present paper • Introduces the impacts of bank regulation and supervision on private loan contracts. • Differentiates the impact on loan prices (due to law and institutional variables) between lending by foreign and domestic lenders. • Shows the different impact of bank regulation and supervision on lending by foreign and domestic lenders

7. Banking-Commerce Integration Effects • Banking-commerce integration has significant impact on firms’ investment decisions. • John, John and Saunders (1994), Saunders (1994), and Prowse (1990), among others • The benefits and costs of banking-commerce integration. • Barth, Caprio, and Levine (2004)

8. Banking/ Commerce Intergration: Impacts • Sharing information • Lower agency costs • Subsidies and transfers

9. Hypotheses • Banking-commerce integration and loan spreads • Hypothesis 1: Non-financial firms owning bank shares impact on loan pricing: • Domestic banks: negative • Foreign banks: positive • Hypothesis 2:Banks owning non-financial firms: same expected impacts

10. Banking concentration • Market-power theory • Banks collude and use their market power to extract monopoly rents • Efficient-structure theory • Concentration increases overall efficiency as more efficient banks grow more rapidly than less efficient ones

11. Hypotheses • Banking concentration and loan spreads • Hypothesis 3: Concentration of assets • Increases market power and spreads for domestic banks • Improves efficiency and reduces spreads for foreign banks • Hypothesis 4:Concentration of deposits: Same hypotheses for different metric

12. The base specification • Similar to that in Qian and Strahan (2005): • Three legal origin dummies • Private credit • Rule of Law • Creditor Rights • Borrower’s credit ratings, SIC dummies • Loan purpose, loan type, syndicated loan, covenant dummies, loan size, the number of lenders

13. Data • Using DealScan database for loan and borrower information. • Employing World Bank survey for bank regulation and supervision information. • The data set contains 54,279 loan facilities covering 49 countries for the period January 1989 to April 2004.

14. TABLE 3 - Selected countries in our Sample Banks owning Non-financial Private Rule Creditor Concentration Concentration Country Legal Origin non-financial firms own Credit of Law Rights of Assets of Deposits firms bank shares Restricted Permitted Argentina French 0.2457 5.35 1 0.499 0.495 Australia English 0.514 10 1 0.76 0.74 Permitted Permitted Belgium French 0.756 10 2 0.88 0.87 Permitted Permitted Brazil French 0.2716 6.32 1 0.536 0.629 Unrestricted Unrestricted Canada English 0.6603 10 1 0.8 0.874 Permitted Restricted ……… Denmark Scandinavian 0.3406 10 3 0.9 0.805 Restricted Permitted France French 0.8201 8.98 0 0.6 0.7 Permitted Unrestricted Germany German 1.1396 9.23 3 0.2 0.21 Permitted Permitted India English 0.2248 4.17 4 0.4353 0.4096 Restricted Restricted Italy French 0.572 8.33 2 0.512 0.522 Permitted Restricted Japan German 1.1641 8.98 2 0.464 0.457 Restricted Permitted ………. Mexico French 0.1305 5.35 0 0.8018 0.8032 Restricted Restricted Peru French 0.2708 2.5 0 0.825 0.8506 Permitted Permitted Spain French 0.8587 7.8 2 0.532 0.437 Unrestricted Permitted Sweden Scandinavian 0.411 10 2 0.62 0.9 Unrestricted Permitted Switzerland German 1.687 10 1 0.72 0.69 Permitted Unrestricted USA English 0.4596 10 1 0.3 0.29 Restricted Restricted United Kingdom English 1.181 8.57 4 0.23 0.24 Unrestricted Unrestricted

15. Main findings • Banking-commerce integration and banking concentration are important determinants of loan prices. • Domestic and foreign lenders react differently to host countries’ regulation and supervision practices. • In countries with high integration of banking and commerce, domestic lenders charge lower spreads and foreign lenders extract higher loan rents • In countries with higher banking concentration, foreign lenders tend to provide favorable contract terms.

16. Main findings-continued • The benefit of lower loan costs received from domestic lenders vanishes in countries with high banking concentration. • We present corroborative evidence that host countries’ legal and institutional variables are important determinants of international loan contracts terms. • In some cases the impact of these variables on loan prices differs between domestic and foreign lenders.

17. Table 7 - Banking-Commerce Integration and Banking Concentration Interactions Regression 1 Regression 2 Regression 3 Domestic Foreign Domestic Foreign Domestic Foreign Scandinavian Origin Dummy -0.826 *** -0.442 *** -0.734 *** -0.492 *** -0.663 *** -0.566 *** (0.2299) (0.0735) (0.2102) (0.0783) (0.2015) (0.0752) French Origin Dummy -0.747 *** -0.191 *** -0.626 *** -0.384 *** -0.741 *** -0.422 *** (0.1003) (0.05) (0.1080) (0.0556) (0.1573) (0.0605) German Origin Dummy -0.317 ** -0.04 -0.679 *** -0.090 -0.701 *** -0.053 (0.1433) (0.0637) (0.2017) (0.0676) (0.2027) (0.0677) Private Credit -0.077 -0.237 *** 0.247 -0.326 *** 0.274 -0.329 *** (0.2034) (0.0766) (0.2520) (0.0775) (0.2724) (0.0783) Rule of Law -0.187 *** -0.077 *** -0.134 *** -0.079 *** -0.211 *** -0.086 *** (0.0464) (0.0137) (0.0521) (0.0142) (0.041) (0.0144) Creditor Rights -0.222 *** -0.065 *** -0.139 ** -0.162 *** -0.155 *** -0.149 *** (0.0453) (0.017) (0.0626) (0.0219) (0.0571) (0.0212) Bank Own Non-financial Firms -0.345*** 0.048** -0.391 *** 0.068 *** (0.1305) (0.0225) (0.1293) (0.0215) Concentration of Assets 0.006 -0.429*** (0.3106) (0.1065) High concentration dummy -0.848 -0.192 * (0.615) (0.1025) Bank Own Non-financial Firms*High concentration 0.453 * 0.049 (0.2537) (0.0521) *******Various Loan Specific Controls here******* US dummy 0.319 *** 0.296 *** 0.041 0.012 0.049 0.117 (0.0653) (0.06) (0.2040) (0.0868) (0.1918) (0.0792) cons 7.785 *** 6.2 *** 7.796 *** 6.239 *** (0.4635) (0.1235) (0.4817) (0.1251) Obs # 29,659 5,537 29,659 5,402 29,659 5404 Adj. R-sqr 0.4521 0.4321 0.4524 0.4393 0.4526 0.4381

18. Robustness checks • We conduct various robustness checks by: • Excluding U.S. data • Bootstrapping • Controlling for additional loan features

19. Conclusions • Differences in countries bank regulation and supervision practices impact loan pricing • Lender identity (domestic vs. foreign) plays an important role in the determination of loan pricing. • The favorable effects of equity link between the bank and the firm on loan pricing vanish in countries with high banking concentration.