Abstract
Cross-country comparisons of average loan interest rates, often carried out using statistics provided by national and international authorities, should be accompanied by strong caveats. If underlying compositional differences in loans, borrowers or lenders are unaccounted for, claims of over/under-pricing may be unfounded. In this paper, we propose a simple methodology that compares interest rates between countries after controlling for such differences. We apply our method to loan-level data from three Irish banks lending to Small and Medium Enterprises (SMEs) in both Ireland and the UK. We find that controlling for such factors reduces the the cross-country interest rate premium significantly. We attribute any remaining interest rate “gap” to overall lending market conditions – for example, to differences in the recoverability of collateral, the level of competition among banks, the aggregate perception of risk, or banks’ expectations on the relative movements in policy rates and exchange rates between the UK and the euro area.
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Notes
See for example the following quotation from, “SME financing, market innovation and regulation,” Speech by Benoit Coeuré, Member of the Executive Board of the ECB, Eurofi High Level Seminar organised in association with the Irish Presidency of the Council of the EU, Dublin, 11 April 2013: the effectiveness of monetary policy itself has been hindered by financial fragmentation, in particular against the backdrop of a sovereign debt crisis in some euro area jurisdictions. As a result, the accommodative monetary policy stance set by the Governing Council has affected firms rather unevenly.”
Draghi speech: Building the bridge to a stable European economy, at the annual event “Day of the German Industries” organised by the Federation of German Industries, Berlin, 25/9/2012, http://www.ecb.europa.eu/press/key/date/2012/html/sp120925.en.html.
See Berger (2006) for a pre-financial-crisis analysis of the likely competitive effects in SME lending markets of the Basel II capital reforms. He predicts that there were likely to be significant anti-competitive effects from the reforms on large banks not adopting the Advanced Internal Ratings Based approach of Basel II. (Saurina and Trucharte 2004) carry out a similar pre-reform analysis using Spanish credit registry data.
An examination of non-financial corporation lending rates in the UK and Ireland available from national authorities shows a 1.5 percentage point premium in the latter (based on average monthly interest rates in 2015). This comparison is used for illustrative purposes only. The UK rates are sourced from the Bank of England and are a weighted average of “other” loans (“new advances”) up to and including £1 million. Irish rates are sourced from the ECB and are for loans other than revolving loans and overdrafts, convenience and extended credit card debt (“new business”) up to and including €1 million. The differential among loans in our data set is larger than this.
This paper is also discussed in Brewer (2009).
This data is collected by the Central Bank of Ireland and captures all outstanding SME lending at Allied Irish Banks, Bank of Ireland and Permanent TSB on June 30th 2015.
The Primary sector is comprised of agriculture, forestry and fishing.
To protect the confidentiality of the banks submitting the LLD to the Central Bank of Ireland, we do not report sample splits by bank or by internal rating category. Furthermore, within this amortising loans sample, our regressions are not able to control for loan product type as this information is missing for the UK firms.
Assets of three largest commercial banks as a share of total commercial banking assets. Total assets include total earning assets, cash and due from banks, foreclosed real estate, fixed assets, goodwill, other intangibles, current tax assets, deferred tax assets, discontinued operations and other assets.
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McCann, F., Carroll, J. Observables and Residuals: Exploring Cross-Border Differences in SME Borrowing Costs. J Financ Serv Res 56, 167–184 (2019). https://doi.org/10.1007/s10693-017-0285-2
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DOI: https://doi.org/10.1007/s10693-017-0285-2