What determines the interest rate on loans granted to small- and medium-sized enterprises (SMEs)? Over the past decades, credit scoring technologies have tremendously developed but bankers often rely on their experience and distrust the blind use of quantitative information. Thus, the decisions to grant a loan and the financial conditions attached to it are taken on the basis of a mixture of statistical methods ("rules") and subjective judgments ("discretion"). In a recent TILEC discussion paper, Geraldo Cerqueiro, Hans Degryse and Steven Ongena, from Tilburg University, estimate a model of the determinants of interest rates to SMEs in the US and Belgium. Unexplained deviations from a very predictive linear loan-pricing model are
interpreted as evidence of the banks' discretionary use of market power in the loan rate-setting process. From the analysis, it emerges that "discretion" plays a large role if (i) loans are small and uncollateralized; (ii) firms are small, risky and difficult to monitor; (iii) firms' owners are older, and (iv) the banking market where the firm operates is large and highly concentrated. Overall, the costs banks face in searching information and borrowers' difficulty to switch lenders seem to be the main sources of market power in the credit market.
