Interest Rate and Cost Differentials in Bank Lending to Small and Large Business

Abstract

T HE data currently available on commercial bank business loan rates' show that the interest rates paid on commercial bank business loans are higher for smaller than for larger loans and for smaller than for larger size business borrowers. Table i shows the survey results for I955 and I957. As was also shown in the earlier surveys, interest rates vary inversely with size of borrower and there is a close positive relationship between size of loan and size of borrower. For these later surveys, further cross-classification was not shown. The I946 survey, however, did provide further classification; this survey showed that when size of borrower is held constant the interest rate declines steadily with increasing size of loan. This may be attributable to costs which are fixed per loan and do not, therefore, vary with size of loan. If this is so, then the cost per dollar of loan decreases as the size of loan increases and must be reflected in higher interest charges for smaller loans. The 1946 survey also shows that when size of loan is held constant interest rates decline with increased size of borrower. This may be due to greater cost of investigation and administration or greater risk associated with lending to borrowers, or it may be due to price discrimination by size of borrower. Such discussion of the observed rate differentials as has taken place has noted that large borrowers pay lower rates than small borrowers and has inferred from this that borrowers are discriminated against in the business loan market.2 If a firm charges different prices to two buyers (or groups of buyers) for units of a product which is physically homogeneous, this may be because: a) price discrimination is being practiced, that is, there is no cost justification for the difference; or b) there is a difference in the cost of servicing the two buyers (or groups of buyers). This might, for instance, take the form of a difference in transport cost because of the different distances of the two buyers from the source of supply. For price discrimination to be practiced several conditions must be met: 3 aq) The seller must hnTss?ess market tnowr. Tin TABLE I. INTEREST RATES ON AND AVERAGE LOAN SIZES OF MEMBER BANK LOANS TO BUSINESS I955 AND I957, BY SIZE OF BORROWER