How Bank Regulation, Supervision and Lender Identity Impact Loan Pricing: A Cross- Country Comparison Li Hao Debarshi K. Nandy Gordon S. Roberts Schulich School of Business York University Toronto, Canada

2 Overview Barth, Nolle, and Rice (1997) document a wide range of banking structures and supervisory practices across countries. Demirguc-Kunt, Laeven, and Levine (2004) highlight the importance of bank regulation and supervision.  Bank regulation affects net interest margins and overhead costs. We address how differences in a country’s bank regulation and supervision practices impact financial activities.

3 Research Goals To examine how differences in a country’s bank regulation and supervision practices impact loan pricing after accounting for the effects of the country’s legal and institutional characteristics. To investigate whether bank regulation and supervision practices have different impacts on the lending pattern and loan prices of foreign and domestic lenders.

4 Bank regulation and supervision variables Banking-commerce integration Banks own non-financial firms Non-financial firms own banks Banking concentration Concentration of assets Concentration of deposits

5 Law, Institutions and the determinants of Loan Price Qian and Strahan (2005):  Test how legal and institutional variables affect loan pricing.  Provide evidence that loan contracts reflect differences in investor protection and law enforcement.

6 The determinants of loan price The present paper  Introduces the impacts of bank regulation and supervision on private loan contracts.  Differentiates the impact on loan prices (due to law and institutional variables) between lending by foreign and domestic lenders.  Shows the different impact of bank regulation and supervision on lending by foreign and domestic lenders

7 Banking-Commerce Integration Effects Banking-commerce integration has significant impact on firms’ investment decisions. John, John and Saunders (1994), Saunders (1994), and Prowse (1990), among others The benefits and costs of banking- commerce integration. Barth, Caprio, and Levine (2004)

8 Banking/ Commerce Intergration: Impacts Sharing information Lower agency costs Subsidies and transfers

9 Hypotheses Banking-commerce integration and loan spreads  Hypothesis 1: Non-financial firms owning bank shares impact on loan pricing:  Domestic banks: negative  Foreign banks: positive  Hypothesis 2: Banks owning non-financial firms: same expected impacts

10 Banking concentration Market-power theory  Banks collude and use their market power to extract monopoly rents Efficient-structure theory  Concentration increases overall efficiency as more efficient banks grow more rapidly than less efficient ones

11 Hypotheses Banking concentration and loan spreads  Hypothesis 3: Concentration of assets  Increases market power and spreads for domestic banks  Improves efficiency and reduces spreads for foreign banks  Hypothesis 4: Concentration of deposits: Same hypotheses for different metric

12 The base specification Similar to that in Qian and Strahan (2005):  Three legal origin dummies  Private credit  Rule of Law  Creditor Rights  Borrower’s credit ratings, SIC dummies  Loan purpose, loan type, syndicated loan, covenant dummies, loan size, the number of lenders

13 Data Using DealScan database for loan and borrower information. Employing World Bank survey for bank regulation and supervision information. The data set contains 54,279 loan facilities covering 49 countries for the period January 1989 to April 2004.

15 Main findings Banking-commerce integration and banking concentration are important determinants of loan prices. Domestic and foreign lenders react differently to host countries’ regulation and supervision practices.  In countries with high integration of banking and commerce, domestic lenders charge lower spreads and foreign lenders extract higher loan rents  In countries with higher banking concentration, foreign lenders tend to provide favorable contract terms.

16 Main findings-continued The benefit of lower loan costs received from domestic lenders vanishes in countries with high banking concentration. We present corroborative evidence that host countries’ legal and institutional variables are important determinants of international loan contracts terms.  In some cases the impact of these variables on loan prices differs between domestic and foreign lenders.

18 Robustness checks We conduct various robustness checks by:  Excluding U.S. data  Bootstrapping  Controlling for additional loan features

19 Conclusions Differences in countries bank regulation and supervision practices impact loan pricing Lender identity (domestic vs. foreign) plays an important role in the determination of loan pricing. The favorable effects of equity link between the bank and the firm on loan pricing vanish in countries with high banking concentration.