Sorry, we’re closed: loan conditions when bank branches close and firms transfer to another bank

Using a dataset with information on new loans granted in Portugal, we find that when firms switch to a new bank they are able to obtain lower interest rates. This result is in line with previous findings in the literature.

However, the existing literature fails to explain which of two competing explanations drive these results. On one hand, banks may offer lower rates to compensate firms for the costs they face when switching. On the other hand, lower rates in new loans may be related with lock-in effects in firm-bank relationships. When a bank gains an information monopoly over a firm, it is able to charge higher interest rates. By engaging in new relationships, firms are able to break these lock-in effects, obtaining lower rates.

Empirically, it is very challenging to understand which of the two competing hypotheses dominates. We are able to explore a set of events exogenous to firms that allows us to identify which of the channels is at work. When the closest branch of a bank closes, firms are faced with an exogenous shock and might adapt by establishing new relationships with banks in their vicinity. How do banks price loans granted to a pool of new borrowers knocking at their door?

If rates on new relationships are low to compensate firms for switching costs, we should still observe a discount in rates. If we do not, banks are probably pool-pricing the inflow of new loan applications coming from borrowers of the branch that closed. In this situation, banks do not need to offer a discount, as the informational link between the firm and its bank is broken.

We find that when firms switch banks after a branch closure, they are not able to obtain any discount. The results are similar for other loan terms. Our results are thus consistent with the hypothesis that firms obtain lower rates when they switch banks because of lock-in effects with existing borrowers.

Click here to go to the paper by Diana Bonfim, Gil Nogueira and Steven Ongena