Abstract
Uncertainty in economic environment leads economic agents to act cautiously. In this paper, we postulate that such uncertainty leads banks to charge higher interest rate on loans. Measuring aggregate country-level economic uncertainty with the World Uncertainty Index (WUI) and using a bank-level dataset from 88 countries over the period 1998–2017, we find that heightened economic uncertainty increases bank loan interest rates. Specifically, bank loan interest rates rise by 20.67 basis points with a one standard deviation increase in WUI. Our results are robust when we use alternative proxy of uncertainty, include additional controls in the model, and extend the sample size. We also observe that WUI index is better at measuring local economic uncertainty as compared to the Economic Policy Uncertainty (EPU) index. Overall, this study provides evidence that bank price in economic uncertainty is an important risk while setting interest rates on bank loans.
Highlights
Uncertainty about economic environment has an important bearing on the decision making of economic agents at the micro-level
We examine the impact of economic uncertainty on bank loan pricing
Using a cross-country bank-level dataset from 88 countries over the period 1998–2017, we find that banks increase interest rates on loans in response to heightened economic uncertainty
Summary
Uncertainty about economic environment has an important bearing on the decision making of economic agents at the micro-level. In this regard, Francis et al (2014) use data from the U.S. and examine the impact of firm-level exposure to political uncertainty on bank loan spreads. Ashraf and Shen (2019) employ bank-level data from 17 countries and examine the impact of economic policy uncertainty on bank loan prices They measure economic policy uncertainty with news-based EPU index developed by Baker et al (2016). Risks 2021, 9, 81 interest rates incorporate the premium for borrowers’ credit quality Asquith et al (2005), the level of competition in borrower’s industry Valta (2012); Waisman (2013), the level of overinvestment by the borrower Ge et al (2017), and the quality of corporate governance of borrowing firm Huang et al (2018), among others Extending this debate, we provide comprehensive evidence how economic uncertainty impacts bank loan interest rates.
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