Bank Capital, Borrower Power, and Loan Rates
João A. C. Santos
Federal Reserve Bank of New York
University of Minnesota - Twin Cities - Carlson School of Management
May 6, 2013
EFA 2009 Bergen Meetings Paper
AFA 2010 Atlanta Meetings Paper
We test the predictions of several recent theories of how bank capital affects the rates that banks charge their borrowers. Consistent with previous studies, higher bank capital has a negative impact on loan rates, and this effect is focused on bank-dependent borrowers. Further investigation shows that borrower cash flow is a critical determinant of this relationship: compared to high-capital banks, low-capital banks charge more for bank-dependent borrowers with low cash flow, but offer greater discounts for bank-dependent borrowers with high cash flow. Our results support the bank-fragility theory, which argues that low bank capital generally toughens bank bargaining power, especially vis-a-vis low-cash-flow borrowers, but weakens bank bargaining power vis-a-vis high-cash-flow borrowers. By contrast, our results are not consistent with models where low-capital banks either consume reputational capital or are generally more risk averse than high-capital banks.
Number of Pages in PDF File: 49
Keywords: Bank loans, bank capital, loan spreads, cash flow, hold-up, information monopolies
JEL Classification: E51, G21, G32
Date posted: February 18, 2009 ; Last revised: February 1, 2014
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