SIZE OF BANK, SIZE OF BORROWER, AND THE RATE OF INTEREST

Abstract

I THE EVIDENCE THAT is available shows that interest rates charged on business loans by commercial banks tend to vary inversely with the size of the loan being made and therefore with the size of the borrower making the loan, since smaller borrowers tend to make smaller loans.' Several explanations have been offered of this fact that interest rates charged small borrowers tend to be greater than interest rates charged large borrowers. One explanation is that the costs of making loans to small borrowers tend to be greater than the costs of making loans to large borrowers. Many costs tend not to vary with the size of loans; consequently, costs as a percentage of loan value decrease with loan size and therefore with the size of the borrower. In addition, the absolute size of the costs of investigating credit worthiness may be greater for small borrowers than for large borrowers.2 A second explanation is that lenders ask larger risk premiums on loans to small borrowers than on loans to large borrowers, other things the same. Professor Alhadeff has proposed a third explanation of the fact that smaller borrowers appear to pay higher interest rates than larger borowers, and it is with this explanation that the present paper is concerned.3 Alhadeff recognizes that differential costs and, perhaps, differential risk premiums undoubtedly play a role,4 but he maintains that, to explain fully the higher rates charged small borrowers, one must consider . . the nature of the market in which large borrowers deal. Alhadeff takes as the starting point of his analysis the observed