The Impact of Organizational Structure Lending Technology on

The Impact of Organizational Structure & Lending Technology on Banking Competition Hans Degryse Cent. ER - Tilburg University, TILEC, K. U. Leuven & CESIfo TILEC-AFM Chair on Financial Market Regulation Luc Laeven IMF & CEPR Steven Ongena Cent. ER - Tilburg University, TILEC & CEPR Con ference on ”The Changing Geography of Banking”, 1

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! 2

“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 3

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

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

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

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” 7

Data: We combine two data sets 1 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 – ¨ Relationship Characteristics – ¨ Origination Date, Loan Rate, Collateral, Repayment Duration, Purpose, Other Main Bank and Duration Firm Characteristics and Identity (incl. Address) 8

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

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 10

Dependent Variables 11

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

Other Control Variables 13

Other Control Variables (cont’d) 14

Table 2: Impact on Branch Reach 15

Table 4: Spatial Pricing 16

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 17

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 18