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The Impact of Organizational Structure & Lending Technology on Banking Competition

The Impact of Organizational Structure & Lending Technology on Banking Competition. Hans Degryse CentER - Tilburg University, TILEC, K.U. Leuven & CESIfo TILEC-AFM Chair on Financial Market Regulation Luc Laeven IMF & CEPR Steven Ongena CentER - Tilburg University, TILEC & CEPR

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The Impact of Organizational Structure & Lending Technology on Banking Competition

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  1. The Impact ofOrganizational Structure & Lending Technology on Banking Competition Hans Degryse CentER - Tilburg University, TILEC, K.U. Leuven & CESIfo TILEC-AFM Chair on Financial Market Regulation Luc Laeven IMF & CEPR Steven Ongena CentER - Tilburg University, TILEC & CEPR Con ference on ”The Changing Geography of Banking”, Ancona, September 2006

  2. Motivation: Bank Organization & Spatial Pricing • Bank’s internal organization matters for lending Stein (JF 2002); Takats (ECB 2004); Liberti (2004); Liberti & Mian (2005), Berger et al. (JFE 2005) • Opaque (small) firms borrow from close banks Petersen & Rajan (JF 2002); Saunders & Allen (2002) • Large, centralized banks lend to distant, large firms using hard information Berger, Miller, Petersen, Rajan & Stein (JFE 2005); Cole, Goldberg & White (JFQA 2004) • Banks spatially price loans Petersen & Rajan (JF 2002); Degryse & Ongena (JF 2005); Bharath, Dahiya, Saunders & Srinivasan (JFE 2006), Agarwal & Hauswald (2006) Bank’s internal organization matters for branch reach and spatial pricing of loans Also rival banks’organization matters This paper!

  3. “Objective” Information “Travels Better” than “Subjective” Information Transportation Costs Differ: “Number of visits” or “mode of communication” By borrower to bank By bank to borrower may differ if banks’ organization implies different types of information Subjective or Soft information: more visits Objective or Hard information: fewer or no visits

  4. Transportation Cost Model: stylized version with linear transportation costs • Banks A, B located at endpoints of line (length 1) • Transportation costs tiper unit of distance, shaped by internal organization of bank i • Consider borrower at location x • Cost visiting A: tAx • Cost visiting B: tB(1-x) • Cost taking loan at A: rAx + tAx • Cost taking loan at B: rBx + tB(1-x)

  5. Equal Linear Transportation Costs Now introduction different costs, but for graphical purposes, we assume tA= t. Loan Rate t -2t MC = 0 0 1/2 1 Bank A Bank B Distance

  6. Drop in tB (e.g., B employs more objective information):A’s reach shrinks and spatial pricing becomes softer Loan Rate tA tB tA+ tB - (tA+ tB) MC = 0 0 1/2 tB / (tA+ tB) 1 Bank A Bank B Distance

  7. In the paper, we also model: • Non-Linear transportation costs • Banks with different marginal costs • “Soft Firm – Hard Firm” and “Soft Bank – Hard Bank” • “Soft firms” generate more soft information • If bank A has a comparative advantage in soft information: • Bank A’s reach decreases when B becomes “harder” • But less so for “soft firms”

  8. Data: We combine two data sets 1 Portfolio from one Belgian bank 17,776 loans to 13,104 borrowers in August 1997 Degryse & Van Cayseele (JFI 2000); Degryse & Ongena (JF 2005) sole proprietorships (81%), small, medium, and large firms • Loan Characteristics • Origination Date, Loan Rate, Collateral, Repayment Duration, Purpose, Other • Relationship Characteristics • Main Bank and Duration • Firm Characteristics and Identity (incl. Address)

  9. Postal Zone 837 Postal Zones; 7,477 Bank Branches Lender also possible Competitors 6 km Borrower 6 km

  10. Distance = shortest traveling time, in minutes • to Lender • to Closest quartile (Bank) Competitor in the borrower’s postal zone 17,776 + 293,170 borrower - bank branch combinations Recording errors; 801 at closing branches; 1% - screen(postal zone check) 612 contracts in postal zones without competitors 15,044 remaining contracts

  11. Dependent Variables

  12. 2 Bank organization variables (source: Belgian Bankers` Association)

  13. Other Control Variables

  14. Other Control Variables (cont’d)

  15. Table 2: Impact on Branch Reach

  16. Table 4: Spatial Pricing

  17. Differential Effects & work in progress • Effect of hierarchy on branch reach is smaller for small firms with limited liability • Effect of hierarchy on spatial pricing is larger for small firms with limited liability • Not incorporated in paper yet: • Layers to Telex softens spatial pricing • Span of control: little impact

  18. Conclusions • Simple model shows that: • Branch reach and severity of spatial loan pricing depend on the organization of competing banks • Empirical Tests: • Branch reach shrinks • Rival bank is large, hierarchical, or has fax • Spatial pricing softens • Rival bank is large or hierarchical

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