Download Switching Costs in Local Credit Markets by Barone, Felici and Paganin

Comments on the paper:
Switching Costs in Local
Credit Markets by Barone,
Felici and Pagnini
Fabrizio Mattesini
Università di Roma “Tor Vergata”
Conference on the “Changing Geography of Banking”
Ancona September 22/23, 2006
 The paper is an interesting analysis of competition in
local credit markets and on the nature of bank firm
relationships
 If switching from one bank to another is costly for the
firm, banks will exploit their monopoly power and
i) charge higher interest rates to old customers
ii) firms will tend to stick to the old bank, i.e. lenderborrower matches will tend to be state dependent.
 There is however a different possible explanation
behind the decision to switch bank
 In a situation of asymmetric information the decision
to switch bank could signal that the switcher is a low
quality borrower to which the host bank denied credit.
 In this case the authors argue we should observe
higher interest rates charged to new customers and
few borrowers switching
 Very interesting paper
 Impressive data set which allows the
researcher to analyze the details of firm-bank
relationships
 Empirical analysis rigorous and well done
Only few comments:
 The authors present a very clearcut situation between switching
costs and adverse selection effects.
 But are we so sure that adverse selection would lead banks to
charge higher interest rates to new customers?
 Sharpe (1990), for example, obtains a totally different result in a
model of repeated corporate borrowing under adverse selection
in which lenders obtain insider information on borrowers quality
 In this model Sharpe argues that since borrowers and lenders
rationally anticipate the possibility of being informationally
captured, initial finance is offered at a discount which reflects the
future markup on future terms of finance.
 Indeed, Von Thadden (2004) argues that Sharpe’s
solution of the model is wrong and that the model
admits only a mixed strategy equilibrium where very
few firms switch and those that switch are charged a
higher interest rate.
 My point, however, is that adverse selection models
are known to produce very different results. I am not
sure whether finding a positive or a negative interest
rate differential between new and old firms allows us
to discriminate clearly between the two hypotheses
 My suggestion is that the authors, in order to
better disentangle the issue, try to
complement the analysis with some other
information on the firms’ characteristics
 In other words, what types of firms are the
ones that switch? Are they sistematically less
profitable, more indebted and therefore more
risky than the one that remain locked in?
The empirical analysis:
 Only few remarks
 In the estimated equation, the interest rate
does not depend on any measure of the firm’s
riskiness.
 I am worried that, without accounting for it, an
interest rate equation might be misspecified.
 If you worked in a panel dimension you could
use firm specific effects.
 Some sort of misspecification might indeed
be behind a somewhat puzzling result: you
find evidence of significant switching costs,
but, on the other side, you find that firms with
single banking relationships pay much lower
interest than those with multiple bank
relationships
 Since this is probably due to the quality of
borrowers, you should try to consider this in
the analysis.
 As for the analysis of state dependence, I find
the methodology correct and useful.
 The paper gives us some very interesting
estimates of the size of switching costs
 It would be interesting to have a larger
number of estimates of swtching costs, that
could be associated to the characteristics of
local credit markets (industrial districts,
underdeveloped areas……)
One last general remark:
 The paper gives us a picture of the Italian credit
market that is, for me, quite surprising
 The paper shows a very large number of firms
lending only from one bank. In Rome, for example,
only 4770 firms out of 16020 had more than one
banking relationship
 Moreover, 87 per cent of credit extended to each firm
came from a main bank
 For firms having only one bank relationship, the
switching rate ranges between 3 and 4 per cent,
while for firms with two or more relationships the
switching rate ranges between 23 and 28 %
 This gives the impression of a “main bank
system” rather than the traditionali Italian
system based on “multiaffidamento”
 Further analysis on the issue would be
extremely important:
 What type of firms are locked in? What is the
relation with the local productive structure or
the level of development? Does the nature of
the banking system (local banks versus
national banks) affect the number and the
strength of relations?