Does Transparency about Banks' Lending Costs Lower Firms' Borrowing Costs? Evidence from India

Abstract

We study the impact of transparency about banks' costs on loan interest rates. The Indian Central Bank required banks to disclose a cost-based benchmark interest rate instead of the prime rate. The banks could price loans using any spread to the cost-based benchmark. We find that this change, which made banks' cost structures more transparent, lowers the interest rates charged and leads to increases in debtor firms' total borrowings and investments. We hypothesize that increased cost transparency reveals relationship rents to competitor banks and makes it difficult for incumbent banks to maintain high relationship rents because of increased threat of entry.

Keywords: Bank Transparency, Benchmarks, prime rate, Bank Transparency, Cost-Based Benchmark Interest Rate, Prime Rate, Loan Interest Rates, Relationship Banking, Lending Costs, Borrowing Costs, Bank Competition, India, Reserve Bank of India, Credit Market Efficiency, Financial Regulation, Banking Sector, Interest Rate Transparency, Base Rate, Regulatory Impact, Credit Markets, Corporate Borrowing, Competition in Banking, Informational Rents