Loan Pricing: Do Borrowers Benefit from Cost-Efficient Banking?

Abstract

This study examines the loan-pricing behavior of German banks for a large variety of retail and corporate loan products. We find that a bank’s operational efficiency is priced in bank loan rates and alters interest-setting behavior. Specifically, we establish that a higher degree of operational efficiency leads to lower loan markups, which makes prices more competitive and smoothes the setting of interest rates. By employing state-of-the-art stochastic frontier efficiency measures to capture a bank’s operational efficiency, we take a look at the bank customers’ perspective and demonstrate the extent to which borrowers benefit from cost-efficient banking. * This paper has benefited from the comments of research seminars at the University of Cologne in 2012 and 2013 and at the Deutsche Bundesbank in 2012. We also thank the participants of the 2013 VHB annual meeting in Wuerzburg and the participants of the 2013 EEA annual meeting in Gothenburg for their useful comments. We also owe many thanks to an anonymous referee of this journal. An earlier version of this paper which circulated under the title “Determinants of the interest rate pass-through of banks − evidence from German loan products” is part of the first author’s Ph.D thesis (Schlueter, 2012) and available as Bundesbank Discussion Paper No 26 / 2012.