Bank Market Power and Loan Contracts: Empirical Evidence

Abstract

Using a sample of syndicated loan facilities granted to US corporate borrowers from 1987 to 2013, we directly gauge the lead banks’ market power, and test its effects on both price and non‐price terms in loan contracts. We find that bank market power is positively correlated with loan spreads, and the positive relation holds for both non‐relationship loans and relationship loans. In particular, we report that, for relationship loans, lending banks charge lower loan price for borrowing firms with lower switching cost. We further employ a framework accommodating the joint determination of loan contractual terms, and document that the lead banks’ market power is positively correlated with collateral and negatively correlated with loan maturity. In addition, we report a significant and negative relationship between banking power and the number of covenants in loan contracts, and the negative relationship is stronger for relationship loans.

Banking market concentration and syndicated loan prices

“…Therefore, our empirical results so far suggest that syndicated loan prices are sensitive to bank concentration of both borrower's market (H1) (e.g. Hasan et al 2017;Lian 2017) and lead arranger's market (H2) but not participant lenders' market (H3).…”

“…In particular, borrowers would be charged higher prices, such as fees (commitment fee and annual fee) and overlibor, if they locate in a more concentrated bank market, supporting both H1 and H2. Specifically, a standard deviation increase in borrower's market bank concentration (CR50 Borrower ) would increase fees by 3%, consisting with Lian (2017) and Hasan et al (2017). A standard deviation (0.12) increase in CR50 Lead would raise the overlibor of a typical syndicated loan by 4.15 base points, equivalent to around $152,000 additional costs for a borrower with an average size of syndicated loan ($366 million).…”

“…To examine the 'bank concentration -loan price' relationship, recent empirical studies have focused on the structure (HHI or Lerner Index) of borrower's bank market (e.g. Hasan et al 2017;Lian 2017). Such an investigation has become increasingly important since the removal of interstate banking and branching restrictions by Interstate Banking and Branching Efficiency Act (IBBEA) in 1990s.…”

“…We calculate the state level market concentration of the participant lenders based on the loan shares they hold 8 . We use state-level bank concentration instead of bank level market power in the analysis because whether a lending bank exercises its market power is mainly dependent on local bank market structure (Hasan et al 2017). CRk has been widely used in measuring bank market concentration (Bikker and Haaf 2002) and in specific, we make a distinction 7 We measure market concentration at a state level for three reasons.…”

“…Hence, such a 'three party' game involves additional adverse selection and moral hazards problems (Ivashina 2009) and lenders from different bank markets may have different pricing mechanisms in loan syndication. Whereas, there has been little empirical evidence on the 'price-concentration' relationship in a syndicated loan setting, except for Lian (2017) and Hasan et al (2017) which have investigated such a relationship in borrower's market only. To advance our understanding on such a relationship in syndicated loan, we consider the effects of bank competition from all three markets (lead arranger, participant lenders and borrower) on syndicated loan prices and in addition, we also investigate the moderating effects of lender types on such a 'price-concentration' relationship where non-commercial banks and non-bank institutions usually charge higher prices than commercial banks (Lim et al 2014).…”