Local Bank Competition, Loan Rates and Risk

Abstract

This paper investigates the effect of competition on the relation between borrowers’ risk and interest rates in the market for business loans. I estimate the relationship between the loan rates and risk of closure conditional on the local market structure using detailed data on loan payments between individual firms and banks from Norway. The findings show that increased competition is associated with lower rates for less risky and higher rates for more risky loans. Comparing markets with three competing banks compared to a single bank, rates for loans to firms that closed down during the loan period were approximately 50 basis points higher, while loans to firms that did not close down were approximately 20 basis points lower.