Bank Concentration, Credit Quality and Loan Rates

Studies that estimate the effect of bank market concentration on the supply of credit to firms typically find economically modest effects. This could stem from concentration affecting firms differentially, thereby causing the sample of borrowers to be endogenous. This paper finds that high bank concentration increases loan rates by 70 basis points, on average, when account is taken of the borrower pool selection process. This effect is three times larger than that obtained when the sample of borrowers is taken as given. The difference in estimates may be explained by an adverse shift in the qualitative composition of the borrower pool. Specifically, high concentration seems to both attract loan applications from lower-quality firms and induce banks to grant credit to these firms.