1. 1 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 Con ference on ”The Changing Geography of Banking”, Ancona, September 2006

2. 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. 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. 4 Transportation Cost Model: stylized version with linear transportation costs  Banks A, B located at endpoints of line (length 1)  Transportation costs t i per unit of distance, shaped by internal organization of bank i  Consider borrower at location x –Cost visiting A: t A x –Cost visiting B: t B (1-x) –Cost taking loan at A: r Ax + t A x –Cost taking loan at B: r Bx + t B (1-x)

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

6. 6 Drop in t B (e.g., B employs more objective information): A’s reach shrinks and spatial pricing becomes softer 0 1 1/2 Bank A Bank B MC = 0 t A + t B Loan Rate Distance tAtA tBtB - (t A + t B ) t B / (t A + t B )

7. 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. 8 Data: We combine two data sets 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) 1

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

10. 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. 11 Dependent Variables

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

13. 13 Other Control Variables

14. 14 Other Control Variables (cont’d)

15. 15 Table 2: Impact on Branch Reach

16. 16 Table 4: Spatial Pricing

17. 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. 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