Bank Loan Markups and Adverse Selection

46 Pages Posted: 1 Dec 2020 Last revised: 23 Nov 2021

See all articles by Mehdi Beyhaghi

Mehdi Beyhaghi

Federal Reserve Banks - Federal Reserve Bank of Richmond

Cesare Fracassi

University of Texas at Austin

Gregory Weitzner

McGill University

Date Written: November 19, 2020

Abstract

We analyze the relationship between loan pricing and market concentration in the US corporate loan market by creating a measure of markup using banks’ internal loan risk assessments. Our risk-adjusted measure of markup is orthogonal to the subsequent performance of loans, while a measure that excludes banks’ private risk assessments strongly predicts performance. Consistent with theories in which asymmetric information across banks creates adverse selection which drives markups, we find that markups are higher in less concentrated regions. We provide further support for the adverse selection channel by showing that markups are higher among firms that are more subject to asymmetric information and when firms stay with their existing banks. Finally, higher local markups are associated with lower loan volume and higher levels of collateralization. Our findings suggest that adverse selection drives markups, loan volume and lending standards in local bank markets and have implications for antitrust policy.

Keywords: bank loans, adverse selection, market power

JEL Classification: G21, G28, L13, L44, G32

Suggested Citation

Beyhaghi, Mehdi and Fracassi, Cesare and Weitzner, Gregory, Bank Loan Markups and Adverse Selection (November 19, 2020). Available at SSRN: https://ssrn.com/abstract=3733932 or http://dx.doi.org/10.2139/ssrn.3733932

Mehdi Beyhaghi

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

Cesare Fracassi

University of Texas at Austin ( email )

McCombs School of Business
2110 Speedway Stop B6600
Austin, TX 78712-1276
United States
512-232-6843 (Phone)

HOME PAGE: http://https://faculty.mccombs.utexas.edu/cesare.fracassi/

Gregory Weitzner (Contact Author)

McGill University ( email )

1001 Sherbrooke St. W
Montreal, Quebec H3A 1G5
Canada

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