Francisco Rodríguez and Santiago Carbó
Universidad de Granada and FUNCAS (Fundación de las Cajas de Ahorros Confederadas para la Investigación Económica y Social)

Recent changes in banking markets have generated a debate about the role of banks as lenders. Liberalisation and bank consolidation have been intensified while competitive pressures increase as nonbank competitors and mutual and pension funds expand. Many banks are reducing their share of loans in the balance-sheet and increasing the weight of securities. At the same time, banks are increasingly involved in off-balance sheet business such as derivatives and mutual funds. Deregulation, consolidation and the explosive growth of mutual fund business within depository institutions make the Spanish banking industry a particularly interesting case of study. What drives bank willingness to concentrate on banking activities? Which variables explain bank credit market competition? Using longitudinal data analysis we find that some factors such as bank size, relationship lending, the weight of mutual funds, different measures of bank concentration and efficiency have been specially significant for both bank specialisation in lending activities and the loan to deposit rate spread.

1. Introduction

Banks represent a crucial source of credit for many families and firms. In recent years, several changes have altered the structure of banking activities and the role of banks as lenders. Liberalisation has brought a decline in net-interest margins and the increasing competitive pressures led banks to invest a growing share of their assets portfolio in industrial participations and securities and to intensify their off-balance sheet business such as mutual and pension funds. However, bank loans' demand has increased during the last decade in many countries. Some institutional factors such as bank size, level of service, specialisation or relationship-lending have to be considered to explain how banks face this demand and the changes in the relative importance of loans on balance-sheet.

Microeconomic determinants of bank lending

Bank institutions have also faced increasing funding and regulatory pressures. Capital regulatory constraints have triggered a trend towards capitalisation as a response to minimum-reserves requirements and to reinforce the market-value of the bank institution itself. At the same time, changes in saving preferences have substantially affected bank liabilities. Households have shifted out from checking accounts and saving and time deposits to mutual funds. Even if banks may increase their non-interest income by selling mutual funds, the faster growth of these assets comparing with short-term bank creditors might become a substantial liquidity constraint for banks to create new loans.

The fast growth of off-balance sheet activities together with the processes of innovation, liberalisation and internationalisation, have contributed substantially to changes in the traditional view of banks as assets transformers -taking short-term liabilities and making long-standing loans. Although banks' traditional assets share is declining comparing to those of mutual or pension funds, the role of intermediaries in the financial system is still important. The way intermediaries are gathering a growing share of financial assets can be explained by two main reasons. In one hand, in those financial systems where bank institutions have been traditionally allowed to participate in activities such as mutual funds, they have rapidly controlled almost entirely that business. On the other hand, in some other countries -specially those with a marketbased financial system- banks have not been allowed until recent years to be involved in these activities and other types of intermediaries -as non-bank financial institutionshave boosted the relative importance of intermediation even while bank institutions share declined (Allen and Santomero, 1998).

Together with competitive pressures, advances in information technology, service improvements and capital regulation, banks have also experienced substantial transformations in their market structure in recent years. The removal of geographical branch restrictions in many countries and the global trend towards consolidation have changed the distribution of bank business at local, regional, nationwide and international levels. Market concentration together with factors such as size, efficiency and specialisation may then also affect bank loan supply in a particular territory.


(1) where M = (1. regulation.67). Even if bank funding and investment channels are not that simple. Relationships between regulation. for example. Not only brokerage but also quality transformation -dealing with informational asymmetries and 3 . this equation illustrate the traditional functions carried out by financial institutions: their demand for liquidity (deposits plus interbank markets) and their supply of loans for a given set of prices.r) L + (r (1.Microeconomic determinants of bank lending This paper aims to analyse the impact of mutual fund activities.L).L) = (rL .) – rD) D . Section 4 reports on the main theories explaining the effects of changes in market structure and efficiency on bank prices and profits. Bhattacharya and Thakor (1993) survey some of the main contributions in the banking literature to justify the special role of banks as financial intermediaries. Freixas and Rochet. The methodology and the definition of variables used in the empirical analysis are described in section 5. 1997. Section 2 is a brief background of previous literature explaining the current role of banks as intermediaries and the future of bank traditional activities. The changing structure of banking activities: Do mutual funds represent a trend towards disintermediation? In a traditional model of bank behaviour in a competitive banking sector (see. market structure and size on bank lending using cross-section time-series analysis for a representative sample of Spanish commercial and saving banks from 1993 to 1998. L)): π(D.C(D. individual banks are seen as price takers and they will adjust their volume of loans (L) and deposits (D) in such a way that their marginal cost equal their intermediation margins (rL – r and r (1-α) – rD) and bank profits are the sum of their loan and deposits margin minus their management costs (C(D. size and bank lending are explored in section 3.)D – L expresses the net position of the institution in the interbank market. Section 6 carried out a panel data analysis for lending by banks in Spain regarding on changes in the ratio of loans on total assets and the loan to deposits rate spread from 1993-1998. p. Equation (1) represents the traditional role of bank as asset transformers. 2. The paper ends with some concluding remarks.

has been used several times to describe the declining share of assets held by banks in the intermediation business. The term disintermediation. However. Allen and Santomero (1998) find that the share of assets held by banks (and insurance) firms is decreasing while non-bank financial institutions and mutual and pension funds have raised their importance as intermediaries in the United States. As reported by Allen and Santomero (1998). Apilado and Kolari (1996.176).some other factors –as risk management and participation costs. for instance illustrate how the dramatic decline in short-term 4 .have been the main reasons reported on banking literature to shed light to the question of why banks are special. transaction costs and information asymmetries can be -indeed.was first termed as disintermediation when actually depositors were using an intermediate channel to finance firms. When banks were eventually allowed to be involved in the mutual fund industry. p. The question behind this discussion is actually if banks are losing a part of their importance as intermediaries. however. 1 These factors can help to explain why banks are increasingly involved in off-balance sheet and fee-earning business (as mutual and pension funds) Disintermediation can be seen as a transformation from institution-based to market-based financial systems.have to be taken into account to explain properly the current and wider role of bank intermediaries in the global financial assets industry. 2 Gallo. the large expansion experienced by mutual funds in the United States -when banks were not permitted until recent to deal with mutual funds.Microeconomic determinants of bank lending transaction costs. in recent years –with the substantial reduction in transaction costs and information asymmetries. A more appropriate term to describe this competition could be 'redesigned-intermediation'.argued to explain the role of banks in traditional activities (basically taking deposits and making loans). a new set of possibilities was opened and they could actually increase their intermediation activities. As explained by Golter (1996). The increasing growth of mutual funds and non-bank financial institutions does not necessary mean a trend towards disintermediation.2 1 Participation costs are defined as those coming from the day-to-day learning of (and participation in) the markets while risk management is included because of the increasing complexity and number of market instruments and the transfer of the inherent risk of operating in those markets to the financial intermediaries.

mutual funds has to interest rates during the 1990s encouraged depositors to shift to mutual funds and banks reacted focusing heavily on the mutual fund business to avoid 'disintermediation'. 3 In the United States -where these assets are mainly managed by nonbank financial institutions. Even if banks may rise their gross income by selling mutual funds. In some other countries. Hackethal and Tyrell (1999) have pointed out. Scott (1995) argue that mutual funds might represent a threat for the savings and time deposits of commercial banks. as they provide liquidity and check-writing facilities -specially the money-market. Hackethal and Tyrell (1999) report on the state of bank business in France. The effects of mutual funds growth on banking activities are mixed. 5 . mutual fund assets are largely controlled by banks and distributed via their branch network. Even if there is not a common trend towards disintermediation -and if this is sometimes understood as a lost of importance of commercial banks.mutual funds represent a direct competition for banks.Microeconomic determinants of bank lending Schmidt. becoming an alternative for the current payment system. Gorton and Penacchi (1993) show how a potential and substantial share of lending can move away from depository to non-bank financial institutions. Kaufman and Moat (1994) describe how banks have reduced their share in shortterm business credit to a larger extent than their share of total assets as a result of the expansion of new types of financial institutions. The pace of development and the channels of distribution for mutual funds vary significantly across countries. United Kingdom and Germany finding that there is neither a trend towards disintermediation nor towards a significant declining of banking activities. the decreasing role of bank institutions in the United States should not be extrapolated to the European countries assuming a general decline of banks in all the industrial countries.similar to those services offered by bank deposits. as Schmidt. However. 3 See Walter (1999) for a comprehensive view of the differences of mutual fund growth internationally. Germany or France. as in Spain. In this sense. they have to face the funding pressures coming from a decline in deposits growth rates comparing to those of mutual funds. they observed how non-bank financial institutions are increasing their role as financial intermediaries putting banks under pressure (specially in the case of France). Nevertheless.

as the interbank market and securitisation. MUTUAL FUNDS AND DEPOSITS GROWTH RATES IN SPAIN (1992-1998) Mutual funds (left scale) Deposits (right scale) 12% 10% 8% 6% 4% 2% 0% 1993 1994 1995 1996 1997 1998 1992 profitable business but they do not provide banks with liquidity (as deposits do) to create new loans. Berlin and Mester (1999) argue that one of the factors explaining the 6 . BANK LOANS GROWH AND MUTUAL FUNDS TO DEPOSITS RATIO (1991-1998) Bank loans growth rate (left scale) Mutual funds/deposits (right scale) face some liquidity shortages to create new loans. where mutual funds experienced an unprecedented growth during the nineties. Their results suggest that mutual funds reduce bank risk (but not unsystematic risk) and increase the return on assets (ROA) of banks. Apilado and Kolari (1996) analyse the impact of mutual funds activities on bank risk and profitability. could be not enough by themselves to solve liquidity shortages and this type of funding is expensive compared to deposits. long-standing customer relationship and cross-selling opportunities.Microeconomic determinants of bank lending be taken into account because of the many implications they have on banking activities. This is likely the case of Spain where mutual funds growth rates have been considerably higher than those of deposits (figure 1). These alternatives. As mutual funds grow rapidly and deposit accounts shrink sharply banks may FIGURE 2. as it happened in Spain during the second half of the nineties (figure 2). 0.800 0. 0% 1991 1992 1993 1994 1995 1996 1997 1998 however. Banks are specially well-positioned to offer these saving products because of their distribution channels.200 20% 15% 10% 5% Some other alternatives relevant to became generate increasingly liquidity. Mutual funds are a 70% 60% 50% 40% 30% 20% 10% 0% FIGURE 1.600 0. A new question arises: Do mutual funds activities carried out by banks contribute to a decrease in traditional -say lendingbanking activities? Gallo. as in Spain.400 0. in particular in those countries. Even if mutual funds may reduce the pressures of the dramatic drop in net interest margins they pose many other implications for banking activities as they are perceived by depositors as a substitute for deposit accounts.

As large banks enrolled in the mutual fund and securities business strongly. There is a concern in the banking literature about the future role of banks in lending activities.that rely more on bank finance.Microeconomic determinants of bank lending declining role of the banking sector in the credit markets has been the weak growth of core deposits. size and the role of bank as lenders Capital requirement standards. Regulation. they have decreased the relative weight of loan over total assets compared with small banks although diversification and changes in the banking industry are affecting all types of banking institutions. Small and medium depository institutions (specially savings banks) are intensifying their participation in bank credit markets and becoming increasingly relevant in loan supply to households and firms at the local and regional levels. Widespread changes in regulation have largely contributed to a substantial transformation in bank strategies and activities. Changes in bank capital requirements have affected bank asset and liability structure. liberalisation and the relaxation of barriers to interstate mergers and interstate branching in many countries have represented a challenge for the banking industry. These effects have been very different across countries depending on the level of the capital to assets ratio held by banks and the characteristics of the minimum reserves regulation prior to the adoption of the new "own funds" requirements standards. specially for those loan categories -as small business. 7 . 3. Shrieves and Dahl (1995) attempt to identify the causes of the so-called 'credit crunch' at the beginning of the nineties in the United States concluding that not only credit market factors but also new capital regulations should be consider to clarify the contraction of bank lending. competition. Minimum reserves requirements and external market pressures have stimulated an increase in bank capital to asset ratios. Relationships between bank lending and capital have been extensively studied recently.

Strahan and Weston (1998) study the relationships between lending to small business. Their empirical findings suggest that loan interest rate were positively related to bank supply of loans while loan delinquency rates affected negatively. Small banks possess better information about the local (regional) markets they are operating in (Samolyk. Changes in bank capital might then affect bank loans and real economic activity. bank institution size and complexity and consolidation.led banks to both reductions in lending (more than dollar per dollar) and deposits. There is a concern about the future of bank lending to certain borrowers assuming that small firm finance rely more on depository institutions and specially on those small-medium banks that operate at regional and local levels. 8 . if there is any capital reduction. Firstly. 1999). Bank capital was found to have a positive effect on bank loan supply either to meet minimum reserves requirements or because a bank itself might be willing to increase its capital to asset ratio considering market-related pressures.Microeconomic determinants of bank lending Peek and Rosengren (1995) explained how a reduction in capital -together with binding capital requirements. Hancock and Wilcox (1994) develop a model of bank loan supply and borrower demand for bank credit. deposits increase and loans fall (but less than dollar per dollar). Some relevant factors have been observed in many studies related to changes in bank size. they find evidence of an increase in the importance of small business loans on small banks' portfolio while large banks expand their share of large firms loans (and decrease small business lending) rapidly with size. Hancock and Wilcox (1998) find that reductions in capital levels in the United States between 1989 and 1992 in both large and small banks tend to reduce bank lending and real economic activity. When banks are not constrained by binding capital requirements. mergers and acquisitions between small bank institutions increase bank lending while other types of merger does not present a significant change. These negative effects were found to be higher for small banks as they are supposed to offer 'high powered' loans (that is. small firms and households are more dependent on the credit given by small banks). Secondly.

Relationship lending may determine. Bank lending in large banks’ subsidiaries is less sensitive to cash flow evolution-as they can benefit from internal capital markets. Another relevant point to clarify the changing patterns in the role of banks as lenders is relationship lending. Bank lending to small firms and households rely specially in relationship lending advantages to solve the problem of information asymmetries. organisation structure (affiliated and unaffiliated banks) and size. Relationship lending is. unaffiliated banks (mainly small and medium size banks) have a higher proportion of liquid assets and capital to assets ratios. 1994). showing that small-medium banks focus more on relationship lending and standardised lending products such as credit-card than large-complex bank holding companies.Microeconomic determinants of bank lending Houston and James (1998) analysed the relationship between bank lending. they show how banks obtain information during the course of their relationship with borrowers to adjust loan contract terms. to a certain extent.and the correlation of affiliated loan growth with aggregate lending in the state they operate is higher than for unaffiliated banks. Berger and Udell (1995) illustrate lending relationships using information on loan rates and collateral requirements of lines of credit. they find evidence of size-related specialisation consisting in large bank offering different types of bank loans from those given by small banks. On one hand. As Petersen and Rajan (1994). These relations have been also pointed out by Samolyk (1999). the special role of depository institutions as lenders. On the other hand. The study also suggests that lending in affiliated banks is more sensitive to changes in local market conditions -offering more money when the market follows an upward trend and reducing lending when conditions are not so favourable-. found to be very useful in describing the current role of banks in finance. A relationship between depository institutions and bankdependent borrowers in a long-standing basis provide banks with precious information (Petersen and Rajan. As Strahan and Weston (1998). Local borrowers should prefer to establish a lending-relationship with unaffiliated banks -strongly linked with local conditions-. then. Petersen and Rajan (1995) illustrate how competition in credit markets may determine bank lending 9 . large banks might benefit from internal capital markets through subsidiaries and allocate capital more efficiently than small banks.

Market structure and bank lending Market competition and efficiency in credit and deposit markets may alter bank prices and profits intensely. Berger (1995) has criticised the use of market concentration measures as a proxy for bank efficiency They argue that market share may account for many different factors related to market power -as product differentiation. alternatively.in a downturn.can lead a bank to higher profits and market shares (Xinefficiency hypothesis). Borrowers establish durable contract relationships with bank lenders and this contract reduce the likelihood of a credit crunch and contribute to loan rates smoothing.4 Performance. 4. Molyneux. because firms with large market shares and differentiated products may increase their profits and rise there prices deliberately (relative-market power hypothesis). Deposits are shown as inter-temporal contracts that smooth banks' cost of funds. A risk-sharing agreement is implicit. Berlin and Mester (1999) study the influence of deposits in relationship lending. first. Lloyd-Williams and Thornton (1994) attempted to identify the features of the Spanish banking industry market structure during the period 1986-1988. Two different theories are held also to explain efficient-structure hypothesis. The second theory rely on significant differences in economies of scale across depository institutions (scale-efficiency hypothesis) 10 . Relationships between performance and profits and market structure have relied upon two major hypotheses: market concentration -which assert that market imperfections result in higher prices and profits. 4 These hypotheses are well developed by Berger (1995) showing two possible related theories for each of both concentration and efficiency hypotheses. The exercise of concentration market-power may consist. prices.Microeconomic determinants of bank lending to credit-market constrained (bank-dependent) borrowers as concentration in a given credit market may benefit from lending-relationships. 1998).and efficiency structure hypothesis -more efficient institutions might have lower costs and higher profits. The first one of them asserts that a reduction in costs -as a result of better managerial abilities and/or production technologies than competitors. Borrowers' cost of funds is protected from exogenous shocks -and lending shortages. in either higher loan to deposits rate spread as a consequence of competitive imperfections in the market (structure-conduct-performance hypothesis) or.and not only efficiency (see also Maudos. concentration and efficiency measures used to determine crucially the empirical findings.

5 The introduction of efficiency in regressions where the market share variable is statistically significant does not affect the value of the parameter estimate of market share prior to the introduction of efficiency in regressions which indicates that market share is effectively a proxy of market power in these equations. Figure 3 shows the average branch concentration for both local (provincial) and regional markets in Spain from 1986 to 1998. The evidence in this study support the modified efficient structure hypothesis as efficiency and market share affect bank performance significantly5 while concentration -as a proxy for market power.Microeconomic determinants of bank lending They found support for traditional structure-conduct-performance hypothesis. We consider provincial HHI computations as many Spanish depository institutions operate in a few provinces and provincial HHI should be. A common measure to establish a relation between market power and market concentration is the Herfindahl-Hirschman Index (HHI). they use a market share variable to test for efficiency-structure hypothesis. Although both measures of market concentration exhibit a similar trend. The HHI has been extensively used as it considers both the distribution of the market share and 11 . In 1989. far more relevant than regions. and the collusion/efficiency hypothesis which states that performance is related to both bank efficiency and concentration. The level of competition in the relevant market has to be inferred appropriately to describe market structure.6 As there is not information available for the distribution of deposits (or loans) across regions (or provinces) in Spain. Maudos (1998) study the relationship between market structure and bank performance (ROA and ROE) in Spanish banking from 1990 to 1993 employing a direct measure of efficiency using translog functional forms. The relevant market for local depositors and borrowers is the province level since they rarely have access to markets outside their own province. 6 This index can be defined as the sum of the squared market shares of bank institutions in their relevant market.was found to be irrelevant. HHI computations for provinces were found higher in average and more sensitive to changes in market conditions. previous studies of the banking industry have used branch information as a proxy for deposit concentration. However. then. Two hybrid hypotheses are tested together with the usual efficiency-structure and market concentration hypotheses: the modified efficient-structure hypothesis -which postulates that changes in bank performance are motivated by efficiency plus a residual effect of market share-.

Cetorelli (1999) illustrate how market power and market concentration measures (such as HHI) are not always justified. 12 . This study shows how different tests of the structure-conduct-performance (SCP) hypothesis for the Italian banking industry -using indirect concentration measures of market power (HHI) and direct econometric analysis of banks’ competitive behaviourlead to different results. Even if there is no information available of bank loans and deposits at local and regional levels and previous studies of Spanish banking 0. 7 Cetorelli (1999) illustrate how alternative measures of market structure based on econometric modelling of market demand and supply conditions -conjectural analysis.000 FIGURE 3.may provide an accurate information about bank's competitive behaviour. However.200 0. Relying on theoretical models of conduct.250 0. Theories which regard a monotonic relationship between market power and concentration measures will be correctly identified under some restrictive assumptions about depository institutions and borrowers behaviour7. the analysis could be improved using the average loan (deposit) branch values to compute the HHI for loan and deposit markets at both regional and local levels and compare them.050 0. saving banks) merged as competition intensified and concentration grew. econometric results contradicted these hypothesis suggesting a trend from less-competitive conditions to a substantial level of the number of bank institutions in each market. the effects of liberalisation have progressively reduced concentration in regional and local markets to levels similar to those of the beginning of the period. While the concentration measures provided with evidence that support a progressive approximation from a high level of competition to a gradual increase of concentration and market power. many institutions (basically. At the beginning of the 1990s.100 0.150 0. showing that an individual change in bank prices will not be followed by changes in prices by competitors. HHI measures of market concentration will be measuring market power properly when banks competitive behaviour is similar to Cournot oligopoly. Finally. some caveats must be taken into account when using concentration measures as an indicator of market power.Microeconomic determinants of bank lending geographical branch restrictions were eliminated in Spain. AVERAGE BRANCH CONCENTRATIO (HHI) IN SPANISH LOCAL AND REGIONAL MARKETS (1986-1998) N PROVINCIAL REGIONAL industry have only used branch 1986 1988 1990 1992 1994 1996 1998 distribution data as a proxy for deposit and loan market concentration.

and on the loan to deposit rate spread in Spain from 1993 to 1998. OLS estimators will be not efficient and the appropriate method of estimation will be Generalised Least Squares (GLS). 13 . the analysis has to be limited to those institutions for whom mutual fund portfolio information is available and can be individually identified. a part of the error term. If this individual-specific effect is supposed to be a random variable that is uncorrelated with the explanatory ones -and then.across individuals (banks in our case) can be modelled under certain assumptions. this restriction does not affect significantly the conclusions derived from our empirical analyses since the 38 institutions included in the sample concentrate more than the 70 per cent of the total banking industry assets. One of the main contributions of longitudinal data analysis is that unobservable differences -persistent heterogeneity.Microeconomic determinants of bank lending market competition at the end of the period considered. methodology and data This paper aims to test for the main determinants of bank lending. econometric analysis suggest a rejection of SCP hypothesis while HHI data contradict these results. If 8 Some small banks that sells mutual funds delegate the fund portfolio management to a company that serves a few banks and keep selling and distribution to customers in branches. In particular. We use longitudinal (panel) data techniques to analyse both cross-section and time series observations. Therefore. 5.then. As we consider Spanish banks’ involvement in the mutual fund business as a meaningful variable to illustrate some of the structural changes occurred in banking activities. The Spanish banking industry is a particularly relevant archetype for our empirical purposes as many of the processes identified in sections 2-4 have been specially significant in Spain during this period. 9 Applying random effects.and a massive growth of bank mutual fund off-balance-sheet business. Relevance of the Spanish case. have been some of the main transformations in the Spanish banking industry of the last decade. it studies the effects of a set of posited explanatory variables on bank lending likelihood -measured as the importance of loans on bank portfolio.together with a trend towards consolidation -with differential strategies for small and large depository institutions. a 'random effects' estimation should be applied9.8 Nevertheless. A high degree of liberalisation -with a substantial decrease in short-term interest rates.

LLSS. The dependent variable in the first equation will be the relative weight of bank loans on bank assets portfolio -regarding the effect of structural changes in the relative importance of lending activities. fixed effects still produce consistent estimates of the variables of interest. that when random effects estimations are valid.Microeconomic determinants of bank lending we instead suppose that individual effects may vary across time but be constant across individuals. NB is the logarithm of bank branches providing with a measure of the distribution network (service). Small depository institutions in Spain -and specially savings banks. TA refers to the log of total assets.are specialised in lending activities and operate in specific local 10 Another advantage of using panel data improves estimations even with an incomplete list of explanatory variables. Loans are mainly commercialised in bank offices and borrowers -specially local ones. The first equation is defined as follows: LNTA = f (NB.value bank branching facilities. Two equations are tested using fixed and random effects estimators. When including CATR we will refer to this equation as equation (2b). TA) (2a) We will also consider the capital11 to assets ratio (CATR) to test for relationships between bank capital and lending likelihood and exclude total assets (TA) because correlation between both variables alter estimations significantly introducing bias12. LCMS. however. DUMM96. 12 While introducing 'capital to assets ratio' and 'total assets' together in the same equation was found to introduce a serious problem of multicollinearity between both variables. 11 Tier 1 and Tier 2 capital definitions. GDP. SPR. measuring the evolution of the importance of bank loans on total assets. the introduction of the number of branches together with the capital to assets ratio did not alter significantly the coefficients of the 14 . Those banks with a large number of branches or increasing their physical distribution channels to customers over time are expected to have a higher proportion of their assets invested in lending. MFST. The dependent variable (LNTA) is loans over total assets. then the 'fixed effects' estimation would be more appropriate and Ordinary Least Squares (OLS) regression will yield unbiased estimators of the coefficients of the parameters of interest10. It should be noted.while the second one regress a group of explanatory variables on the loan to deposits rate spread -analysing changes in loans and deposits prices.

As LLSS grow. LLSS refers to loan losses -as a ratio of non-performing loans on net-interest margins.and working nationwide. MFST is the ratio of mutual funds bank investment on short-term creditors (deposits. interbank market liquidity and short-term securities issued). a dummy variable (DUMM96) has been introduced to control for changes in lending demand prior and after 1996. As these relationships grow. LCMS stands for loan commitments and it includes lines of credit. Unfortunately there is no data available of contract variables (such as duration of loans or collateral) for Spanish banks to test more appropriately the value of relationship lending over time. 15 . The variable takes the value 0 prior to 1996 and 1 otherwise. bank credit risk increases and lending over total assets might decrease as a result of a higher credit risk. Higher differences in loan and deposit prices may encourage banks to concentrate more on bank lending as a higher spread could be the result of a lower level of competition in their relevant credit market. parameters comparing to those obtained before including the capital to assets ratio. Then.Microeconomic determinants of bank lending or regional areas while large institutions -in particular. Since interest rates drop sharply after 1996 and loans demand rises substantially after this year. The loan to deposits rate spread (SPR) accounts for the influence of deposits and loan prices on bank lending. a priori. large commercial banks. the share of loans maintained by a bank might rise because of a better information about borrowers and long-standing relationships. As this ratio increases. bank liquidity constraints may rise with lending if depositors shift out from deposits to mutual funds and bank willingness to lend could decline. We also include LCMS and LLSS as variables related to bank credit management. The GDP growth rate has been included as a proxy for macroeconomic conditions and computed as a branch-weighted average of the regional GDP for those regions where the bank operates. a negative relationship between size and loans over total asses is expected.have diversified their investment portfolios -maybe reducing the relative importance of loans on balance-sheet.

16 .is specified as follows: SPR = f (NB.059123 0.041806 CINFF COST INEFFICIENCIES 0.057145 MSD MARKET SHARE (DEPOSITS) 0.800301 LLSS LOAN LOSSES 0. Data frequency is semi-annual. DEVIATION LNTA LOANS OVER TOTAL ASSETS 0. LCMS.155488 0.014887 SPR LOAN TO DEPOSITS RATE SPREAD 0. MFST is also included in equation 3 since those banks investing in mutual funds business usually operate in more competitive and larger markets and their loan to deposits spread might be lower.69263 4.099731 0.111287 CATR CAPITAL TO ASSETS RATIO 0.327386 NB NUMBER OF BRANCHES (log) 5. MSD.014798 0. HHIL and MSL -HHI and MS for loans. TABLE 1.456540 0. We expect HHID (L) and MSD (L) will be positively related to the SPR as loan (deposits) prices will be higher (lower) in less-competitive markets.will be alternatively included in equation (3b) -and computed following the same methodology.345916 CREDITORS TA TOTAL ASSETS (log) 13. CINFF.105091 0. The number of total panel observations vary from 411 (equations 2) to 383 13 Deposit distribution has been computed using provincial branch distribution. CINNF stands for cost inefficiencies and is defined as the ratio of operating costs over gross income. VARIABLES DEFINITION AND SUMMARY STATISTICS (1993-1998) VARIABLE DEFINITION MEAN STD.089777 0. TA) (3a) where HHID and MSD are the Herfindahl-Hirschman Index and market share computed for deposits as a branch-weighted average of provincial HHI and MS for deposits13. Most efficient banks are expected to operate in most competitive markets and prices (not necessarily profits) should be lower.014080 CAGR LOAN COMMITMENTS (log) 11.186098 HHIL HHI (LOANS) 0.266741 GDP GDP GROWTH RATE 0.38944 2.638429 0.050624 MSL MARKET SHARE (LOANS) 0.051159 MUTUAL FUNDS OVER SHORT-TERM MFST 0.099999 HHID HHI (DEPOSITS) 0.to contrast if deposit and loan market concentration bring us to the same conclusions about the loan to deposit rate spread (SPR).061920 0.152411 Variable means and standard errors are shown in table 1. HHID.142159 0.Microeconomic determinants of bank lending Equation 3 -where the dependent variable will be the loan to deposit rate spread. MFST.256327 0.36790 1.

as expected. GDP coefficients were not found significant. in general. If banks focus on mutual funds and these assets grow faster than deposits and other short-term creditors. 6. Small banks (as many saving banks) are more specialised in lending while large banks diversify more their investment portfolios. Deposit accounts can be found less attractive comparing to mutual funds. MFST is strongly and significantly related to LNTA. as banks are expected to specialise more in lending activities when they can benefit of a higher spread. We find a positive effect of SPR (when applying RE) on LNTA. the NB is found to be significant and.Microeconomic determinants of bank lending (equations 3) depending on data availability. Bank size (TA) coefficient is found to be negative and significant. borrower monitoring and lending relationship will improve with loan commitments such as credit card agreements. indicating that the weight of loans might increase as a result of a larger physical network.are shown in Table 2. Panel Data Results Regression results for the equation (2a) –where the dependent variable is the ratio of loans over total assets (LNTA). positive when RE is applied. Pearson correlation coefficients are shown in the Appendix. According to our hypotheses. depository institutions may be raising their profits selling mutual funds and become less dependent on lending. very similar . 17 . As expected. LCMS and LNTA are positively and significantly related (both FE and RE) as effective lending. Fixed (FE) and random effects (RE) estimations are. LLSS is also significant for RE and achieve the expected negative sign. In equation (2a). specially in Spain where mutual fund income-tax treatment has been significantly favourable. reflecting the impact of a higher credit risk on bank lending. The dummy variable controlling for changes in lending demand is only significant for RE estimations.

141046 (-0.74) 0.22) -0.75) -0.34) --0.86) 0.84) 0.095378** (-1.83) -0.045366 (1.43) 0.22) 0.07621 (1.36 411 -------0.47) -0.096800* (-1.77) 2.300085 (0.044024 (1.696827 (0.063708*** (2.72) 0.247841** (-1.313689 (1.024387 (1.30) -0.41) 0.31) 0.64) 0.87) 0.032287 (1.532221* (1.79) 0.37) 0.101923 (1.480740*** (3.076116 (-1.614726*** (-7.262382** (2.Microeconomic determinants of bank lending TABLE 2.50) -0.09) 0.437991*** (-7. PANEL REGRESSION RESULTS ON LENDING OVER TOTAL ASSETS OF POSITED EXPLANATORY VARIABLES (Equations 2a and 2b) Sample period: 1993(1)-1998(2) Values for t-statistics in parenthesis FIXED RANDOM EFFECTS EFFECTS (a) Equation (2a) CONSTANT NB LLSS GDP DUMM96 SPR LCMS MFST TA NUMBER OF BRANCHES (log) LOAN LOSSES GDP GROWTH RATE 1996 DUMMY LOAN TO DEPOSITS RATE SPREAD LOAN COMMITMENTS (log) MUTUAL FUNDS OVER SHORT-TERM CREDITORS TOTAL ASSETS (log) -------0.152533** (-2.94) -0.30) 0.750071 (0.60) -0.82) 0.357993*** (-2.84) 1.31) 0.10412*** (4.559564* (1.31 411 1.139037*** (3.765124 (0.106266 (1.030488 (0.32 411 Adjusted R2 Number of observations CONSTANT NB LLSS GDP DUMM96 SPR LCMS MFST CATR NUMBER OF BRANCHES (log) LOAN LOSSES GDP GROWTH RATE 1996 DUMMY LOAN TO DEPOSITS RATE SPREAD LOAN COMMITMENTS (log) MUTUAL FUNDS OVER SHORT-TERM CREDITORS CAPITAL TO ASSETS RATIO Equation (2b) Adjusted R2 Number of observations (a) Random effects estimations have been estimated applying Generalised Least Squares Variance Components model * statistically significant at 10 per cent (two-sided) ** statistically significant at 5 per cent (two-sided) *** statistically significant at 1 per cent (two-sided) 18 .43) 1.078147*** (2.107892** (-1.33) 0.68) 0.082119** (2.39 411 -0.079967*** (2.66) -0.507455*** (6.43) 2.46) 1.72) 1.

SPR. Using branch-weighted average of local HHIL we obtain a more meaningful variable for bank market concentration even for those banks that operates in different local (regional) markets. As expected. the coefficients (not shown) were not significant in any case since these wider. depository institutions meet their minimum reserves requirements and increase their lending activities14. regional measures might be less representative of actual relevant market concentration. It should be noted. However. however is more significant (for both RE and FE) in equation (2b) while NB is not significant in this equation (neither RE nor FE estimations). The same comments apply to results obtained in equation (3b) when HHIL and MSL are tested instead of deposit measures. By increasing their capital to assets ratio. 19 . the results obtained introducing loan measures are less statistically significant than those of deposits. the CATR is strongly and positively related to LNTA.Microeconomic determinants of bank lending In equation (2b) the capital to assets ratio has been included as explained in section 5. Results are again very similar in both fixed and random effects. Results for equations 3 –where loan to deposits rate spread (SPR) is the dependent variable. Results for the rest of the parameters are generally similar to those of equation (2a). however. CINNF ratio is also positively and negatively related to SPR suggesting that more cost-efficient banks operate in more competitive markets. In equation (3a) –where deposit concentration measures were usedthe number of branches (NB) is found to be significantly related to SPR as growing physical distribution network could increase traditional activities such as lending. Carbó and Gardener (forthcoming) suggest that CAR (capital adequacy ratios) have successfully contributed to bank capital augmentation in Spain.are shown in Table 3. HHID is found to be significantly and positively related to SPR as a higher concentration in local (provincial) markets may result in a higher (less competitive) loan to deposits spread while MSD was not found significant in any case. that when introducing regional computations of HHID. 14 A recent study carried out by Altunbas. Bank size (TA) coefficient shows a negative sign suggesting that smaller banks exhibit higher spreads between loan and deposit rates than their larger competitors.

016612*** (3.039426** (2.37 0.07) -0.90) -0.003228** (-2.92) -0.28 0.016346*** (-2.59) 0.007066* (-1.096379*** (3.013892*** (3.Microeconomic determinants of bank lending TABLE 3.09) -0.003709 (0.27 383 Equation (3b) (credit market concentration measures) Random effects estimations have been estimated applying Generalised Least Squares Variance Components model * statistically significant at 10 per cent (two sided) ** statistically significant at 5 per cent (two sided) *** statistically significant at 1 per cent (two sided) 20 .009461*** (-3.34 0.75) -0.018352*** (-3.008972*** (-2. PANEL REGRESSION RESULTS ON LOAN TO DEPOSITS RATE SPREAD OF POSITED EXPLANATORY VARIABLES (Equation 3) Sample period: 1993(1)-1998(2) Values for t-statistics in parenthesis FIXED RANDOM EFFECTS EFFECTS (a) Equation (3a) (deposit market concentration measures) CONSTANT NUMBER OF BRANCHES (log) COST INEFFICIENCIES HHI (DEPOSITS) MARKET SHARE (DEPOSITS) LOAN COMMITMENTS (log) MUTUAL FUNDS OVER SHORT-TERM CREDITORS TOTAL ASSETS (log) R2 Adjusted R2 Number of observations CONSTANT NUMBER OF BRANCHES (log) COST INEFFICIENCIES HHI (LOANS) MARKET SHARE (LOANS) LOAN COMMITMENTS (log) MUTUAL FUNDS OVER SHORT-TERM CREDITORS TOTAL ASSETS (log) R2 Adjusted R2 Number of observations (a) -------0.17) -0.85) 0.42) -0.038627*** (2.29 383 -------0.030133 (1.006011*** (4.30 0.74) 0.26 383 0.64) 0.004338*** (3.83) -0.001709 (0.010239 (-0.81) 0.020252 (-0.002739** (-2.013072*** (3.065) 0.48) -0.59) 0.79) 0.33) -0.45) 0.006214 (-1.003657** (-2.29 383 0.80) 0.20) 0.036686*** (2.041181 (0.31) 0.73) 0.42) -0.98) -0.001869 (-1.85) -0.42) 0.14) 0.45) 0.14) -0.22292*** (-3.000250 (0.021482*** (-3.010940*** (3.213067*** (3.

this paper has studied the main determinants of bank lending in Spain form 1993 to 1998. Loan commitments such as credit cards agreements may also improve bank borrower information and lending relationships resulting in a higher proportion of bank loans on balance sheet and lower (higher) loan (deposits) rates. In the last decade Spanish households have been shifting out from deposits to mutual funds and banks have found problems to obtain liquidity. Some interesting conclusions are derived also from bank mutual fund investment. At the same time. Our results indicate that this process has reduced the relative weight of loans on total assets when banks mutual fund business has grown considerably faster than short-term creditors. Liberalisation has resulted in higher competition and consolidation. measures of concentration for both loan and deposits local markets and cost-inefficiencies are found to be positively related with higher loan to deposit spread and less competitive markets. A set of posited variables is regressed on the ratio of bank loan to total assets and on the loan to deposits rate spread. Concluding remarks The banking industry has undergone substantial transformations in recent years. 21 . competing with bank traditional activities. a recent process of bank liberalisation and a trend towards consolidation that make the Spanish banking industry an specially interesting study case. Spanish banks have been specially affected by events such as an explosive mutual funds growth. Using panel data techniques. Our main results suggest that smaller banks specialise more in lending and work with higher loan to deposits rate spreads. non-bank competitors are offering services similar to those of depository institutions and mutual and pension funds –together with derivatives and securities-. Many banks (specially large commercial banks) have focused intensely in mutual funds business. Finally.Microeconomic determinants of bank lending 7.

A (1994): "Bank capital. The MIT Press. G. S. loan delinquencies and real state lending". and KOLARI.P. nº3. and THAKOR. 22 . forthcoming in Applied Financial Economics. L. England.W. W. pp.C. (1993): "Money market funds and finance companies: Are they the banks of the future?" In Structural Change in Banking. 22. G. Economic Perspeectives. and ROCHET. • • • • BERGER. UDELL (1995): "Relationship Lending and Lines of Credit in Small Firm Finance". Federal Deposit Insurance Company Banking Review. J. and WILCOX. (1999): "Competitive analysis in banking: Appraisal of methodologies".Microeconomic determinants of bank lending REFERENCES • • • ALLEN.121-146.27. D. (1996): "Banks and Mutual Funds". ALTUNBAS. CARBÓ. Klausuner and L. 1461-1485. F. White. A. 2-15. X. 2-50. 68. GALLO. London.: "The impact of CAR on bank capital augmentation in Spain". M. Y. Credit and Banking. nº3. pp.V. V. and WILCOX.J. 983-1014. WP.M.2. HANCOCK. 10-20. Vol 8. M and MESTER. J. (1998): "The credit crunch and the availability of credit to small business". and SANTOMERO.404-431. Journal of Business. Journal of Banking and Finance.. CETORELLI.. 3 (2). A. (1997): Microeconomics of Banking. J. pp. (1998): "The theory of financial intermediation". (1999): Deposit and Relationship Lending. S. and PENNACCHI. vol. J. (1996): "Commercial bank mutual fund activities: Implications for bank risks and profitability". Article II.A. E. New York: Irwin. 99-03 BHATTACHARYA. First Quarter. nº1. (1995): "The profit structure relationship in banking-Test of marketpower and efficient-structure hypotheses". 1775-1791 • • GOLTER. nº2 pp. and G. N. Journal of Banking and Finance. A. Federal Reserve Bank of Chicago. • • FREIXAS. The Wharton School Institutional Center. pp. BERLIN. J. Journal of Money. Journal of Housing Economics. and GARDENER. (1993): "Contemporary Banking Theory".G. APILADO.20 pp. D. A. Journal of Financial Intermediation 3. • • HANCOCK. Journal of Banking and Finance 21. GORTON. BERGER. J. pp. vol.

Credit and Banking. G. SCHMIDT. PEARSON CORRELATION COEFFICIENTS FOR MODEL VARIABLES (1993-1998) p-values in parenthesis 23 . pp.110. and DHAL. pp. 18. pp.1-78 APPENDIX. nº2. K (1998): "Mutual funds as an alternative banking system". pp. J. R.Microeconomic determinants of bank lending • • HOUSTON. XVIII. pp. and MOTE.F. SCHMIDT. (1995): "The effect of credit market competition on lending relationships".M. KAUFMAN. 899. J. Blackwell Publishers. • MOLYNEUX P. M and RAJAN. R. P. (1994): "Is banking a declining industry?". (1998): "Small business lending and the changing structure of the banking industry". Journal of Financial Services Research. 2-21. 625-638. Journal of Banking and Finance 22. 14-32 SCOTT. (1998): Do bank internal capital markets promote lending?. (1994): "Market structure and performance in Spanish Banking".5-30. p. and ROSENGREN. Quarterly Journal of Economics. 821-845 • WALTER..918. I. (1998): "Small Business Credit Markets: Why do we know so little about them?" FDIC Banking Review. PETERSEN. C. HACKETHAL. May/June 1994.P. J. pp. M. Journal of Institutional and Theoretical Economics.R. Journal of Banking and Finance. (1999). Issue 3. recession and bank lending behavior. D: (1995): "Regulation. and THORNTON. and TYRELL. Economic Perspectives. pp. May. • STRAHAN. 3. pp.. pp.433-444. Journal of Banking and Finance.E. J. 22. LLOYD WILLIAMS. J. E. vol. L. and WESTON. • • • • • • PEEK.404-443 SAMOLYK. 9. Federal Reserve Bank of Chicago.H. 10. Applied Financial Economics. (1998): "Market structure and performance in Spanish banking industry using a direct measure of efficiency. 86-96.G. The Global Assets Management Industry: Competitive Structure and Performance in Financial Markets Institutions and Instruments.: (1999): "Disintermediation and the role of banks in Europe". The 1990 Credit Crunch". Journal of Financial Intermediation 8. (1995): "The Capital Crunch: Neither a Borrower nor a Lender Be" Journal of Money. 154/1 pp. D. Oxford.8. K.36-67 SHRIEVES R. Vol. • MAUDOS. A. and JAMES. 191200.

081 (0.989) 0.009 (0.000) * statistically significant at 5 per cent (two sided) ** statistically significant at 1 per cent (two sided) 0.440) -0.162) 0.071 (0.312** -0.044) -0. HHIL: HHI for loans. LLSS: Loan losses.000) 0.385** (0.589 CINFF (0..556** (0.045 SPR (0.207** -0.036 0.470) -0.030) 0.322) 0.002) (0. NB: Number of branches (log).000) 0.085) (0. MSL.913** (0.815** 0.000) 0.850) 0.000) (0.074 (0.606) 0.033 MSL (0.000) 0.000) 0.101) 0.828) 0.098* -0.011 (0.000) 0.017) 0.112* -0.379** -0.019 (0.016 -0.207** 0.000) (0.155) 0.114* (0.268** (0.184) (0. SPR: Loan to deposits rate spread.000) (0.000) 0.684) (0.128) 0.067 CTAR (0.032) -0.707** (0.489** (0.131) -0.105* (0.574** (0.286) -0.110* MFST (0.351) 0.000) (0.427) (0. 24 .000) (0.466) (0.020) (0.067) (0.000) 0.080 LLSS (0.508) 0.053 (0.060 0.117* (0.007 (0.143** 0.037 HHID (0.001 HHIL (0.000) -0.066 TA (0.037 0.069 (0.149** -0. MFST: Mutual funds over short-term creditors.126) -0.004 (0.467) 0.046) (0.752) 0. Loans market share. LCMS: loan commitments (log).540** -0.133** -0.312** MSL (0.105* (0.000) (0.042 -0.000) -0.000) -0.083 (0.919) 0.243) (0.397) (0.260** (0.000) -0.036 (0.024 (0.006) (0.283** (0.628) * statistically significant at 5 per cent (two sided) ** statistically significant at 1 per cent (two sided) -0.000) 0.024 MSD (0.398** (0.170** (0.090) -0.077 HHID (0.005 (0.720) (0.000) (0.037 CINFF (0.036 (0.137** 0.037 0.000) PEARSON CORRELATION COEFFICIENTS FOR MODEL VARIABLES (continued) (1993-1998) p-values in parenthesis TA CTAR CINFF HHIL MSL HHID MSD -0.858) 0.000) 0.099* (0.020) 0.099) 0.239) (0.399) (0.123) -0.003) (0.283) -0.389** (0.081 GDP (0.210** MSD (0.000) (0.000) LNTA: Loan over total assets.304** (0.001 0.009 HHIL (0.009 (0.937) 0. GDP: GDP growth rate.073 LCMS (0.000) -0.055 (0.177** 0.085 -0.018 -0. HHID: HHI for deposits.000) -0.046 (0.Microeconomic determinants of bank lending LNTA LNTA NB NB LLSS GDP SPR LCMS MFSTC 0.689) -0.863** 0.758** (0.020 -0.055 -0.160) -0. MSD: Deposits market share. CINFF: Cost inneficiencies.918** (0.049 (0.163** -0.000) (0.455) (0.062 0.000) (0.002) (0.000) 0.849) 0.048 0.071 (0.202** -0.459) 0.182** (0.989) (0.334) 0.041 -0.148** 0.589** CTAR (0.090 0.143) -0. TA: Total assets (log).019) 0.000) -0.329) (0. CATR: Capital to assets ratio.103) 0.238** (0.

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