Finance: Research, Policy and Anecdotes

After a long review process, my paper with Vasso Ioannidou and Larissa Schaefer has been finally accepted by Management Science. While the initial findings with which we started five years ago still stand, lots of additional tests have strengthened the robustness of the findings and - courtesy of review process – we managed to put the results much better into the literature.  Our paper – using loan-level credit registry data from Bolivia – explores differences in foreign and domestic banks’ credit contract terms and pricing models   Previous work has shown that the clienteles of foreign and domestic banks are different (as, e.g., by Atif Mian for Pakistan).  We rather look at differences in loan conditionality across banks when they lend to the same clients in the same month.  We find that foreign banks are more likely to demand the pledging of collateral and give shorter maturity loans.  There is also some evidence that foreign banks provide loans at a lower interest rate, though this result is somewhat less robust. A second finding is that foreign banks rely more on hard information than domestic banks.  Together this suggests that foreign banks can overcome distance–related information constraints by focusing on hard assets and hard information as well as the disciplining tool of shorter maturity. However, we also show that there are limitations, with foreign banks facing higher default rates and lower returns on lending if not using collateral and short maturity as disciplining tools.  

Our work relates to an extensive literature documenting the importance of geographic and cultural distance between borrowers and lenders, which shows that loan contract terms and lending techniques are a critical function of the geographical distance between borrowers and lenders he findings of our paper are consistent with other work that shows that foreign bank entry has a more positive impact in countries with more efficient credit information sharing systems and creditor rights protection. However, our results also show the risks for funding of smaller businesses that comes from foreign bank entry.   If domestic lenders cannot cover the remaining segments of the market, the foreign banks’  stronger reliance on collateral and short maturity loans may reduce the options for firm investment. It may also have important repercussions from a capital allocation perspective as it may imply a shift towards firms with short-term financing needs and with pledgeable assets both on the intensive and extensive margin, limiting the potentially beneficial role foreign banks can play in developing countries.  In a nutshell: no free lunch to be had here!

Overview