1. Bank mergers and lending relationships Judit Montoriol-Garriga Federal Reserve Bank of Boston December 11, 2008 The views expressed herein do not necessary represent those of the Federal Reserve Bank of Boston or the Federal Reserve System.

2. Banking consolidation: a worldwide process

3. Bank mergers in Spain

4. Impact of bank mergers on SMEs  Do bank mergers harm or benefit firm borrowers? Are consolidated banks more likely to terminate their relationships with borrowers? What are the consequences of bank consolidation on prices? Are some particular types of borrowers more likely to be adversely affected by banking mergers? Are some particular types of mergers more likely to adversely affect SMEs?

5. Merger effects  Efficiency gains: Cost savings and revenue enhancement Economies of scale and scope Risk diversification Competitors: forced to become more efficient too  Costs: Market power Lending relationships: “size effect” in lending

6. This paper  Lending relationships Probability of terminating bank-firm relation Probability to start new relation with consolidated bank  Price effect Average interest rate Heterogeneous effects  Borrower size and age  Size of lending banks ”size effect”  Ownership form of lending banks  In-market vs. out-of-market mergers  Banking market concentration

7. Data  Firm data: SABI  Panel data of Spanish SMEs  New born firms & Micro firms  Names of lenders  Bank data: AEB, CECA  Merger information: RENBE (Bank of Spain)  Sample Selection  Lenders: 1996 to 2005  Non financial firms, no listed  Medium and Small Firms (2003/361/EC definition)  674,735 firm-year obs. (124,213 firms) (5.5 obs/firm)

8. Termination of lending relationships Pr(terminate relationship ikt )= =F(Target borrower ikt, Acquirer borrower ikt, Firm controls ikt, Lender characteristics ikt, Time dummies, Province dummies, ε it )  1,351,069 bank-firm-year observations  300,225 bank-firm relationships  Termination rate: 3.78% Target borrowers: 7% Acquirer borrowers: 3.24%

9. Termination of lending relationships  Target borrowers have a higher probability of terminating a relationship  Smallest firms are more harmed

10. Initiation of lending relationships Pr(initiate relationship ikt )= =F(Consolidated borrower ikt, Firm controls ikt, Lender characteristics ikt, Time dummies, Province dummies, ε it )  Lower probability of initiating a new relationship with a consolidated bank  Smallest firms are more harmed

11. The effect of bank mergers on interest rate  Empirical model:  Efficiency gains passed on to borrowers: β<0  Market power, information loss: β>0 Interest Rate it = α + β Merger Indicator +γ Firm characteristics t-1 + θ Lenders charact t-1 + φ Credit market controls t-1 +d t + f i + ε it

12. Main Results: efficiency gains  Interest rates decline  Permanent effect  Target borrowers benefit the most  Overlap borrowers

13. Borrower size and age  Small and young firms: larger decline (continuing borrowers)

14. In-market vs. out-market mergers In-market merger (change in market concentration) Out of market merger

15. In-mkt vs. out-mkt mergers & market power  Market overlap: cost efficiency gains  Out-of-market: risk diversification  Market power does not offset efficiency gains  Change in market concentration determine the extent to which efficiency gains are passed on to borrowers

16. Does self-selection explain the reduction on interest rates?  High quality firms are more likely to continue the relationship, and thus, receive lower interest rates  Pre-existing effect: Merger(t+1) non significant  Correction for self-selection: 1)Pr(Merger t)=F(Firm ikt, Lender ik, ε it ) for each t 2)Interest Rate it = α + β Merger(t) + γ InvMillsRatio *d t + φ controls t-1+ dt + fi + εit Results are maintained

17. Conclusions  Bank mergers reduce small business lending to certain borrowers (micro, target)  Continuing borrowers benefit from mergers  No evidence of “size effect” in lending (large banks and commercial banks)  Efficiency effect offsets market power  Market concentration: potential concern if consolidation goes on  Implications for European Banking market integration

18. Thank you! Questions?

19. Motivation: Spain  Relationship orientation of Spanish banking market  Young and small firms highly dependent on banking finance  SME represent 99.5% of Spanish firms  Bank mergers: banking deregulation and European integration  Banking data at regional level

20. Variables  Average interest rate t = financial expenses t (debt t-1 + debt t )/2  Merger(t) = 1 if at least one lender is involved in a merger between t-1 and t  Merger(t,T) = 1 in all years after one of the firm lender is involved in a merger  Merger(t+1,T) = Merger(t,T) except that =0 in year of merger  Target, Acquirer  Continuing borrowers

21. Benefits for continuing borrowers  Merger gains only to continuing borrowers  But: joint determination of interest rates and termination/continuation decision

22. “Size effect” in lending?

23. Bank size  Most beneficial mergers from the borrower point of view are those involving Two large banks Banks of different size  Not consistent with “size effect” in lending

24. Bank ownership form  Most beneficial mergers from the borrower point of view are those involving Two commercial banks Borrowers of savings banks that are acquirers