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Risk premium and market power in credit markets
Economics Letters 93 (2006) 450 – 456 www.elsevier.com/locate/econbase
Risk premium and market power in credit markets☆ Alfredo Martín Oliver a , Vicente Salas Fumás b , Jesús Saurina a,⁎ a
b
Banco de España, Spain Universidad de Zaragoza and Banco de España, Spain
Received 28 September 2005; received in revised form 29 May 2006; accepted 28 June 2006
Abstract The use of credit risk-adjusted marginal opportunity cost of funds in the computation of the Lerner index for bank loans opens new directions to properly evaluate market power of banks in credit markets, beyond disputed concentration measures. © 2006 Elsevier B.V. All rights reserved. Keywords: Market power; Lerner index; Credit markets JEL classification: G21
1. Introduction Price deviations from marginal production cost of goods or services create well known social welfare losses. Anti-trust policies, such as Mergers Guidelines, foster competition and prices closer to marginal costs by limiting market concentration, but there are situations where more firms in the market do not necessarily imply higher static and dynamic efficiency. These cases are well known in credit markets with severe information asymmetries between borrowers and lenders which creates moral hazard (Petersen and Rajan, 1995) and adverse selection problems (Marquez, 2002), which are solved in a more effective way in less competitive credit markets. Market power and welfare losses have to be evaluated ex post, using direct measures of social performance, as for example the Lerner index. ☆
This paper is the sole responsibility of its authors and the views represented here do not necessarily reflect those of the Banco de España. ⁎ Corresponding author. C/Alcalá 48, 28014 Madrid, Spain. Tel./fax: +34 91 338 5080. E-mail address: [email protected] (J. Saurina).
0165-1765/$ - see front matter © 2006 Elsevier B.V. All rights reserved. doi:10.1016/j.econlet.2006.06.021
A.M. Oliver et al. / Economics Letters 93 (2006) 450–456
451
Computation of the Lerner index requires a proper estimation of the marginal cost of the product, assuming that prices are easy to observe. In bank loans, the computation of the marginal cost requires, among other things, to evaluate the risk premium charged, which is not easy mainly because of lack of data. This probably explains why in studies of banks' market power in the US, research has focused only on deposit products, where such information asymmetries and risk situations are not present (Hannan and Berger, 1991; Hannan and Liang, 1993). Other researches inspired in the structure-conduct paradigm, both in the US (Hannan and Berger, 1989; Berger, 1995) and in Europe (De Brandt and Davis, 2000; Courvoisier and Gropp, 2002; Bikker and Haaf, 2002; Fernández de Guevara et al., 2005), ignore the complications of computing risk-adjusted marginal costs of loans. We provide a methodological improvement in the evaluation of market power in credit markets by properly measuring the marginal cost for different types of bank loans. Our measure of marginal costs for a bank loan combines the risk free interest rate and an estimate of the risk premium obtained from the observed ex-post probability of default in each class of loan products granted by the bank. The ex-post measure of risk already includes the moral hazard and adverse selection effects that are difficult to assess in ex-ante evaluations. We compute the risk-adjusted marginal cost of four loan products over the 1988– 2003 periods, and next we provide estimates of market power before and after adjusting for the risk premium. The results show that estimations of market power and welfare losses can be very different with and without credit risk adjustments and that they differ substantially across loan products. Capital and operating cost of the bank are considered fixed costs, so the analysis of market power is valid for the short run.
2. Price, cost and welfare Standard welfare analysis shows that, in absence of income effects, price deviations from marginal costs creates a welfare loss because there are consumers willing to pay an amount for the good above the cost of producing a marginal unit. The interbank market separates loan and deposit pricing decisions if we introduce the realistic assumption that the marginal operating costs of loans and deposits are either quasi fix in the very short term or impossible to calculate separately for each of the multiple products and services supplied by the bank. Therefore, the assumption we make is that banks have a lower bound marginal cost for the loans they grant equal to the risk free interest rate offered in the money/interbank market.1 But banks face a credit risk in the sense that due to natural economic risk, to moral hazard or to adverse selection situations, there is a positive probability that the loan will be in default at some period of time. Although moral hazard and adverse selection problems can be mitigated combining price with other terms of the loan, such as maturity and collateral, the risk from natural hazards and uncertainties around economic activity of firms and households cannot be perfectly diversified nor avoided and it has to be considered part of the opportunity cost of the loan. Let PD be the probability that a loan of face value 1 will default and let LGD be the amount of the face value of the loan that the bank cannot collect from the defaulted loan (the so called loss given default). If
1
For a review of bank pricing models in different competitive regimes and information conditions, see Freixas and Rochet (1997).
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A.M. Oliver et al. / Economics Letters 93 (2006) 450–456
the interbank risk-free interest rate is r, the marginal opportunity cost of the loan for a risk-neutral bank will be the interest rate R that satisfies the condition that the risk-free value of the loan equals the expected value of the loan, given the risk of default, at the end of the period: 1 þ r ¼ ð1 þ RÞð1−PDÞ þ ð1 þ RÞPDð1−LGDÞ
ð1Þ
That is, the marginal cost R is the interest rate given by: R ¼ ðr þ PDd LGDÞ=ð1−PDd LGDÞ
ð2Þ
If the market-determined interest rate of the loan is R1, the Lerner index or gross profit margin relative to the market price will be equal to: Lerner index ¼ ðR1 −RÞ=R1
ð3Þ
Under conventional assumptions (Tirole, 1988), the Lerner index can be related to measures of welfare losses, for example Harberger's (1964) triangle, as follows: Welfare loss per unit of interest income ¼ 1=2 Lerner index ¼ 1=2ðR1 −RÞ=R1
ð4Þ
3. Data and results for Spanish banks We have monthly quoted annual interest rates for four different loan products (receivables, credit line, personal and mortgages) by each Spanish bank from 1988 to 2003. They are averages of interest rates quoted in new loans granted by the bank during the previous month. Table 1 shows averages across months and banks of marginal interest rates for each loan product. Computation of marginal cost requires estimations of the risk-free interest rate of the economy, of the PD and of the LGD. The risk-free interest rate r is the average daily quoted annual interbank interest rate. The PD is obtained from the Credit Register of Banco de España (CIR), a database that contains information of all loans above 6000 euros granted by Spanish banks to all kind of borrowers as well as an inventory of all the loans that are in default at every point in time. 2 Thus, the PD for a given bank and product at the end of year t equals the proportion between the number of defaulted loans divided by the outstanding number of bank loans at period t. Since there is no detailed information regarding LGD, we use those values set by the Basel Committee of Banking Supervisors in its new capital framework (the so-called Basel II agreement) for the IRB-Foundation approach (i.e. 25% for mortgages, 85% for personal and 45% for receivables and credit line business loans). Table 2 shows the risk-free interbank rate, and the mean values of the marginal cost of each loan product, Ri, from bank level estimations using Eq. (2). The marginal costs of year t use PD estimates for year t + 1 to take into account that banks have to anticipate future credit risk at the time the loan is granted. The Lerner index is summarized in Table 3. To save space, the explicit computation of the welfare loss is omitted since the approximation from Harberger's triangle is straightforward (1/2 of the Lerner
2
Jiménez and Saurina (2004) and Jiménez et al. (in press) explain CIR database thoroughly.
A.M. Oliver et al. / Economics Letters 93 (2006) 450–456
453
Table 1 Average interest rate across banks (%)
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1988–1993 1994–1998 1999–2003
Receivable
Credit line
Personal
Mortgages
16.03 17.07 17.91 17.57 16.99 16.44 13.29 13.07 11.35 8.57 6.89 6.89 6.48 6.50 5.67 5.09 17.00 10.63 5.86
14.74 15.99 17.25 16.46 15.86 14.92 11.71 12.24 10.59 8.11 6.77 6.77 6.81 6.82 6.19 5.72 15.87 9.88 6.25
15.38 16.87 18.26 17.73 17.09 16.05 12.74 13.51 11.95 9.21 7.91 7.91 7.86 8.01 7.33 7.00 16.90 11.06 7.41
14.09 14.83 16.27 16.05 15.03 14.03 10.41 11.00 9.40 6.92 5.64 5.64 5.77 5.78 4.82 4.15 15.05 8.68 5.05
Table 2 Average marginal cost of each product across banks and interbank rate (%)
1998 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1988–1993 1994–1998 1999–2003
Interbank
Receivable
Credit line
Personal
Mortgages
12.40 14.39 14.76 13.20 13.01 12.25 7.81 8.98 7.65 5.49 4.34 2.72 4.11 4.36 3.28 2.75 13.34 6.85 3.44
12.59 14.83 15.14 13.77 14.36 14.61 9.59 10.28 8.98 6.71 5.32 3.54 4.86 5.15 4.07 3.43 14.22 8.18 4.21
14.91 17.19 18.01 17.58 19.01 19.02 13.63 13.18 10.93 7.85 6.22 4.36 5.72 5.94 4.78 3.91 17.62 10.36 4.94
14.52 16.63 17.59 16.38 17.14 16.69 10.89 11.62 9.34 6.55 5.12 3.63 5.15 5.38 4.43 3.64 16.49 8.70 4.45
12.93 14.95 15.24 13.80 13.76 13.05 8.29 9.39 7.90 5.64 4.45 2.85 4.26 4.48 3.40 2.85 13.96 7.13 3.57
Marginal costs are assumed to be equal to the interbank interest rate corrected by the risk that each product entails. Marginal costs have been computed through the equation Rij = (r + PDij · LGDi) / (1 − PDij · LGDi), where Rij is the marginal cost of the product i at bank j, r is the interbank interest rate and PD, LGD are, respectively, the probability of default and loss given default of product i and bank j.
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Table 3 Impact of the credit risk on the computation of the Lerner index
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1988–1993 1994–1998 1999–2003
Lerner index (%) · marginal cost = interbank corrected by risk premium
Lerner index (%) · marginal cost = interbank interest rate
Receivable
Credit line
Personal
Mortgages
Receivable
Credit line
Personal
Mortgages
15.71 10.80 11.30 18.37 12.13 9.02 25.47 17.81 18.05 19.66 21.48 32.95 24.58 19.19 26.84 30.48 12.89 20.49 26.81
− 2.21 − 6.93 − 5.05 − 8.52 − 16.81 − 28.50 − 17.18 − 8.40 − 3.02 3.20 9.93 22.89 16.40 13.84 21.34 30.18 −11.34 − 3.09 20.93
4.18 0.80 4.92 5.27 −1.14 −3.41 15.19 14.87 21.51 25.21 31.87 44.76 31.81 29.03 37.89 43.29 1.77 21.73 37.36
7.45 −1.28 5.29 13.11 7.80 5.52 19.34 14.71 14.76 17.18 19.83 38.31 24.93 21.12 28.52 30.72 6.32 17.16 28.72
22.34 15.78 18.42 25.42 23.46 25.41 41.25 29.94 31.04 33.71 35.19 49.54 35.26 31.20 39.90 43.38 21.81 34.23 39.86
16.13 10.02 14.72 20.05 17.66 17.79 32.11 26.57 27.63 31.49 34.15 51.80 37.80 34.34 45.66 50.18 16.06 30.39 43.96
19.46 14.81 18.92 25.13 23.08 22.38 38.38 31.55 34.07 39.30 43.86 59.25 47.04 43.62 54.18 57.73 20.63 37.43 52.36
11.69 3.34 9.85 18.13 12.73 12.39 23.78 18.05 18.58 20.21 22.27 41.68 28.28 23.90 31.93 34.31 11.36 20.58 32.02
We show the maiden of the Lerner index across banks for each product.
index). The table shows the median3 values of the index every year since 1988 to 2003. The first four columns refer to the index calculated using the risk-adjusted marginal cost of the loan. The last four columns show the index taking as marginal opportunity cost the risk-free interbank rate, for comparison purposes. There are changes over time, differences across products and evidence of overestimation of market power and welfare losses when the risk premium is ignored in the calculation of the marginal cost. The Lerner index is higher during the period 1999–2003, when Spain has been a member of the Euro zone. Previous to 1999 interest rates of credit line were below the risk-adjusted marginal costs, specially around 1993 when Spain was amid a deep recession. Losses in credit lines were compensated with gains from receivables. Thus, banks seemed to be practicing some cross subsidization among loan products. By the end of the period, relative profit margins of receivables and credit lines are fairly similar so cross subsidization may have come to an end. In loans to households, personal loans have higher relative profit margins than mortgages since mid-nineties, although it was lower in years before. Over time relative margin has increased more in the former than in the later. Finally, the comparison between the two calculations of the Lerner index shows that differences in estimated market power and welfare losses can be important. In credit line, the average relative profit
3
Mean values of the Lerner index across banks carry similar conclusions but the median value has the advantage that avoids distortions from outliers.
A.M. Oliver et al. / Economics Letters 93 (2006) 450–456
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margin with risk-adjusted marginal cost during the period 1999–2003 is 21%, while with the risk-free interbank rate as marginal cost is 44%, more than double. On the other hand, in mortgages, with relatively low credit risk, the difference between the two values is only around 3% higher in the risk-free case. This means that in the case of credit line the estimated welfare loss from market power with risk-adjusted marginal cost and Lerner index will be half of that obtained with a profit margin calculated using a nonrisk-adjusted measure of opportunity cost.
4. Conclusion In this paper, we provide estimates of short term market power of banks in Spanish credit markets taking advantage of a bank level data base on marginal prices and true marginal opportunity costs of loans. We observe a period of time not long ago when banks had losses in some loans and profits in others, probably because this solution was better than translate the full marginal cost of each product to the borrower and suffer from severe adverse selection problems in a period of high absolute interest rates (Stiglitz and Weiss, 1981). Second, we see that market power differs across loan products so it is meaningless to talk about more or less competition in credit markets without making a separate analysis of each loan product. Third, absolute estimates of market power and welfare losses can be as low as half when the Lerner index is computed from the risk-adjusted marginal opportunity cost of the loan compared with the value when it is computed using the risk-free interest rate. The effort to obtain true economic marginal costs has proven justified to avoid significant estimation biases in the calculation of welfare losses from market power.
References Berger, A., 1995. The profit–structure relationship in banking: tests of market power and efficiency–structure hypothesis. Journal of Money, Credit and Banking 27, 404–431. Bikker, J., Haaf, K., 2002. Competition, concentration and their relationship: an empirical analysis of the banking industry. Journal of Banking and Finance 26 (11), 2191–2214. Courvoisier, S., Gropp, R., 2002. Bank concentration and retail interest rates. Journal of Banking and Finance 26, 2155–2189. De Brandt, O., Davis, P., 2000. Competition, contestability and market structure in European banking sectors on the eve of EMU. Journal of Banking and Finance 24 (6), 1045–1066. Fernández de Guevara, J., Maudos, J., Pérez, F., 2005. Market power in European banking. Journal of Financial Services Research 27 (2), 109–138. Freixas, X., Rochet, J.C., 1997. Microeconomics of Banking. MIT Press. Hannan, T., Berger, A., 1989. The price–concentration relationship in banking. Review of Economics and Statistics 71 (2), 291–299. Hannan, T., Berger, A., 1991. The rigidity of prices: evidence from the banking industry. American Economic Review 81, 938–945. Hannan, T., Liang, J., 1993. Inferring market power from time-series data: the case of the banking firm. International Journal of Industrial Organization 11 (2), 205–218. Harberger, A.C., 1964. The measurement of waste. American Economic Review 54 (3), 58–76. Jiménez, G., Saurina, J., 2004. Collateral, type of lender and relationship banking as determinants of credit risk. Journal of Banking and Finance 28, 2191–2212. Jiménez, G., Salas, V., Saurina, J., 2006. “Determinants of collateral”. Journal of Financial Economics.
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Marquez, R., 2002. Competition, adverse selection, and information dispersion in the banking industry. The Review of Financial Studies 15, 901–926. Petersen, M.E., Rajan, R.G., 1995. The effect of credit market competition on lending relationships. Quarterly Journal of Economics 110, 407–444. Stiglitz, J., Weiss, A., 1981. Credit rationing in markets with imperfect information. American Economic Review 71, 393–410. Tirole, J., 1988. The Theory of Industrial Organization. MIT Press, Cambridge, MA.
Risk premium and market power in credit markets☆ Alfredo Martín Oliver a , Vicente Salas Fumás b , Jesús Saurina a,⁎ a
b
Banco de España, Spain Universidad de Zaragoza and Banco de España, Spain
Received 28 September 2005; received in revised form 29 May 2006; accepted 28 June 2006
Abstract The use of credit risk-adjusted marginal opportunity cost of funds in the computation of the Lerner index for bank loans opens new directions to properly evaluate market power of banks in credit markets, beyond disputed concentration measures. © 2006 Elsevier B.V. All rights reserved. Keywords: Market power; Lerner index; Credit markets JEL classification: G21
1. Introduction Price deviations from marginal production cost of goods or services create well known social welfare losses. Anti-trust policies, such as Mergers Guidelines, foster competition and prices closer to marginal costs by limiting market concentration, but there are situations where more firms in the market do not necessarily imply higher static and dynamic efficiency. These cases are well known in credit markets with severe information asymmetries between borrowers and lenders which creates moral hazard (Petersen and Rajan, 1995) and adverse selection problems (Marquez, 2002), which are solved in a more effective way in less competitive credit markets. Market power and welfare losses have to be evaluated ex post, using direct measures of social performance, as for example the Lerner index. ☆
This paper is the sole responsibility of its authors and the views represented here do not necessarily reflect those of the Banco de España. ⁎ Corresponding author. C/Alcalá 48, 28014 Madrid, Spain. Tel./fax: +34 91 338 5080. E-mail address: [email protected] (J. Saurina).
0165-1765/$ - see front matter © 2006 Elsevier B.V. All rights reserved. doi:10.1016/j.econlet.2006.06.021
A.M. Oliver et al. / Economics Letters 93 (2006) 450–456
451
Computation of the Lerner index requires a proper estimation of the marginal cost of the product, assuming that prices are easy to observe. In bank loans, the computation of the marginal cost requires, among other things, to evaluate the risk premium charged, which is not easy mainly because of lack of data. This probably explains why in studies of banks' market power in the US, research has focused only on deposit products, where such information asymmetries and risk situations are not present (Hannan and Berger, 1991; Hannan and Liang, 1993). Other researches inspired in the structure-conduct paradigm, both in the US (Hannan and Berger, 1989; Berger, 1995) and in Europe (De Brandt and Davis, 2000; Courvoisier and Gropp, 2002; Bikker and Haaf, 2002; Fernández de Guevara et al., 2005), ignore the complications of computing risk-adjusted marginal costs of loans. We provide a methodological improvement in the evaluation of market power in credit markets by properly measuring the marginal cost for different types of bank loans. Our measure of marginal costs for a bank loan combines the risk free interest rate and an estimate of the risk premium obtained from the observed ex-post probability of default in each class of loan products granted by the bank. The ex-post measure of risk already includes the moral hazard and adverse selection effects that are difficult to assess in ex-ante evaluations. We compute the risk-adjusted marginal cost of four loan products over the 1988– 2003 periods, and next we provide estimates of market power before and after adjusting for the risk premium. The results show that estimations of market power and welfare losses can be very different with and without credit risk adjustments and that they differ substantially across loan products. Capital and operating cost of the bank are considered fixed costs, so the analysis of market power is valid for the short run.
2. Price, cost and welfare Standard welfare analysis shows that, in absence of income effects, price deviations from marginal costs creates a welfare loss because there are consumers willing to pay an amount for the good above the cost of producing a marginal unit. The interbank market separates loan and deposit pricing decisions if we introduce the realistic assumption that the marginal operating costs of loans and deposits are either quasi fix in the very short term or impossible to calculate separately for each of the multiple products and services supplied by the bank. Therefore, the assumption we make is that banks have a lower bound marginal cost for the loans they grant equal to the risk free interest rate offered in the money/interbank market.1 But banks face a credit risk in the sense that due to natural economic risk, to moral hazard or to adverse selection situations, there is a positive probability that the loan will be in default at some period of time. Although moral hazard and adverse selection problems can be mitigated combining price with other terms of the loan, such as maturity and collateral, the risk from natural hazards and uncertainties around economic activity of firms and households cannot be perfectly diversified nor avoided and it has to be considered part of the opportunity cost of the loan. Let PD be the probability that a loan of face value 1 will default and let LGD be the amount of the face value of the loan that the bank cannot collect from the defaulted loan (the so called loss given default). If
1
For a review of bank pricing models in different competitive regimes and information conditions, see Freixas and Rochet (1997).
452
A.M. Oliver et al. / Economics Letters 93 (2006) 450–456
the interbank risk-free interest rate is r, the marginal opportunity cost of the loan for a risk-neutral bank will be the interest rate R that satisfies the condition that the risk-free value of the loan equals the expected value of the loan, given the risk of default, at the end of the period: 1 þ r ¼ ð1 þ RÞð1−PDÞ þ ð1 þ RÞPDð1−LGDÞ
ð1Þ
That is, the marginal cost R is the interest rate given by: R ¼ ðr þ PDd LGDÞ=ð1−PDd LGDÞ
ð2Þ
If the market-determined interest rate of the loan is R1, the Lerner index or gross profit margin relative to the market price will be equal to: Lerner index ¼ ðR1 −RÞ=R1
ð3Þ
Under conventional assumptions (Tirole, 1988), the Lerner index can be related to measures of welfare losses, for example Harberger's (1964) triangle, as follows: Welfare loss per unit of interest income ¼ 1=2 Lerner index ¼ 1=2ðR1 −RÞ=R1
ð4Þ
3. Data and results for Spanish banks We have monthly quoted annual interest rates for four different loan products (receivables, credit line, personal and mortgages) by each Spanish bank from 1988 to 2003. They are averages of interest rates quoted in new loans granted by the bank during the previous month. Table 1 shows averages across months and banks of marginal interest rates for each loan product. Computation of marginal cost requires estimations of the risk-free interest rate of the economy, of the PD and of the LGD. The risk-free interest rate r is the average daily quoted annual interbank interest rate. The PD is obtained from the Credit Register of Banco de España (CIR), a database that contains information of all loans above 6000 euros granted by Spanish banks to all kind of borrowers as well as an inventory of all the loans that are in default at every point in time. 2 Thus, the PD for a given bank and product at the end of year t equals the proportion between the number of defaulted loans divided by the outstanding number of bank loans at period t. Since there is no detailed information regarding LGD, we use those values set by the Basel Committee of Banking Supervisors in its new capital framework (the so-called Basel II agreement) for the IRB-Foundation approach (i.e. 25% for mortgages, 85% for personal and 45% for receivables and credit line business loans). Table 2 shows the risk-free interbank rate, and the mean values of the marginal cost of each loan product, Ri, from bank level estimations using Eq. (2). The marginal costs of year t use PD estimates for year t + 1 to take into account that banks have to anticipate future credit risk at the time the loan is granted. The Lerner index is summarized in Table 3. To save space, the explicit computation of the welfare loss is omitted since the approximation from Harberger's triangle is straightforward (1/2 of the Lerner
2
Jiménez and Saurina (2004) and Jiménez et al. (in press) explain CIR database thoroughly.
A.M. Oliver et al. / Economics Letters 93 (2006) 450–456
453
Table 1 Average interest rate across banks (%)
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1988–1993 1994–1998 1999–2003
Receivable
Credit line
Personal
Mortgages
16.03 17.07 17.91 17.57 16.99 16.44 13.29 13.07 11.35 8.57 6.89 6.89 6.48 6.50 5.67 5.09 17.00 10.63 5.86
14.74 15.99 17.25 16.46 15.86 14.92 11.71 12.24 10.59 8.11 6.77 6.77 6.81 6.82 6.19 5.72 15.87 9.88 6.25
15.38 16.87 18.26 17.73 17.09 16.05 12.74 13.51 11.95 9.21 7.91 7.91 7.86 8.01 7.33 7.00 16.90 11.06 7.41
14.09 14.83 16.27 16.05 15.03 14.03 10.41 11.00 9.40 6.92 5.64 5.64 5.77 5.78 4.82 4.15 15.05 8.68 5.05
Table 2 Average marginal cost of each product across banks and interbank rate (%)
1998 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1988–1993 1994–1998 1999–2003
Interbank
Receivable
Credit line
Personal
Mortgages
12.40 14.39 14.76 13.20 13.01 12.25 7.81 8.98 7.65 5.49 4.34 2.72 4.11 4.36 3.28 2.75 13.34 6.85 3.44
12.59 14.83 15.14 13.77 14.36 14.61 9.59 10.28 8.98 6.71 5.32 3.54 4.86 5.15 4.07 3.43 14.22 8.18 4.21
14.91 17.19 18.01 17.58 19.01 19.02 13.63 13.18 10.93 7.85 6.22 4.36 5.72 5.94 4.78 3.91 17.62 10.36 4.94
14.52 16.63 17.59 16.38 17.14 16.69 10.89 11.62 9.34 6.55 5.12 3.63 5.15 5.38 4.43 3.64 16.49 8.70 4.45
12.93 14.95 15.24 13.80 13.76 13.05 8.29 9.39 7.90 5.64 4.45 2.85 4.26 4.48 3.40 2.85 13.96 7.13 3.57
Marginal costs are assumed to be equal to the interbank interest rate corrected by the risk that each product entails. Marginal costs have been computed through the equation Rij = (r + PDij · LGDi) / (1 − PDij · LGDi), where Rij is the marginal cost of the product i at bank j, r is the interbank interest rate and PD, LGD are, respectively, the probability of default and loss given default of product i and bank j.
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A.M. Oliver et al. / Economics Letters 93 (2006) 450–456
Table 3 Impact of the credit risk on the computation of the Lerner index
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1988–1993 1994–1998 1999–2003
Lerner index (%) · marginal cost = interbank corrected by risk premium
Lerner index (%) · marginal cost = interbank interest rate
Receivable
Credit line
Personal
Mortgages
Receivable
Credit line
Personal
Mortgages
15.71 10.80 11.30 18.37 12.13 9.02 25.47 17.81 18.05 19.66 21.48 32.95 24.58 19.19 26.84 30.48 12.89 20.49 26.81
− 2.21 − 6.93 − 5.05 − 8.52 − 16.81 − 28.50 − 17.18 − 8.40 − 3.02 3.20 9.93 22.89 16.40 13.84 21.34 30.18 −11.34 − 3.09 20.93
4.18 0.80 4.92 5.27 −1.14 −3.41 15.19 14.87 21.51 25.21 31.87 44.76 31.81 29.03 37.89 43.29 1.77 21.73 37.36
7.45 −1.28 5.29 13.11 7.80 5.52 19.34 14.71 14.76 17.18 19.83 38.31 24.93 21.12 28.52 30.72 6.32 17.16 28.72
22.34 15.78 18.42 25.42 23.46 25.41 41.25 29.94 31.04 33.71 35.19 49.54 35.26 31.20 39.90 43.38 21.81 34.23 39.86
16.13 10.02 14.72 20.05 17.66 17.79 32.11 26.57 27.63 31.49 34.15 51.80 37.80 34.34 45.66 50.18 16.06 30.39 43.96
19.46 14.81 18.92 25.13 23.08 22.38 38.38 31.55 34.07 39.30 43.86 59.25 47.04 43.62 54.18 57.73 20.63 37.43 52.36
11.69 3.34 9.85 18.13 12.73 12.39 23.78 18.05 18.58 20.21 22.27 41.68 28.28 23.90 31.93 34.31 11.36 20.58 32.02
We show the maiden of the Lerner index across banks for each product.
index). The table shows the median3 values of the index every year since 1988 to 2003. The first four columns refer to the index calculated using the risk-adjusted marginal cost of the loan. The last four columns show the index taking as marginal opportunity cost the risk-free interbank rate, for comparison purposes. There are changes over time, differences across products and evidence of overestimation of market power and welfare losses when the risk premium is ignored in the calculation of the marginal cost. The Lerner index is higher during the period 1999–2003, when Spain has been a member of the Euro zone. Previous to 1999 interest rates of credit line were below the risk-adjusted marginal costs, specially around 1993 when Spain was amid a deep recession. Losses in credit lines were compensated with gains from receivables. Thus, banks seemed to be practicing some cross subsidization among loan products. By the end of the period, relative profit margins of receivables and credit lines are fairly similar so cross subsidization may have come to an end. In loans to households, personal loans have higher relative profit margins than mortgages since mid-nineties, although it was lower in years before. Over time relative margin has increased more in the former than in the later. Finally, the comparison between the two calculations of the Lerner index shows that differences in estimated market power and welfare losses can be important. In credit line, the average relative profit
3
Mean values of the Lerner index across banks carry similar conclusions but the median value has the advantage that avoids distortions from outliers.
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margin with risk-adjusted marginal cost during the period 1999–2003 is 21%, while with the risk-free interbank rate as marginal cost is 44%, more than double. On the other hand, in mortgages, with relatively low credit risk, the difference between the two values is only around 3% higher in the risk-free case. This means that in the case of credit line the estimated welfare loss from market power with risk-adjusted marginal cost and Lerner index will be half of that obtained with a profit margin calculated using a nonrisk-adjusted measure of opportunity cost.
4. Conclusion In this paper, we provide estimates of short term market power of banks in Spanish credit markets taking advantage of a bank level data base on marginal prices and true marginal opportunity costs of loans. We observe a period of time not long ago when banks had losses in some loans and profits in others, probably because this solution was better than translate the full marginal cost of each product to the borrower and suffer from severe adverse selection problems in a period of high absolute interest rates (Stiglitz and Weiss, 1981). Second, we see that market power differs across loan products so it is meaningless to talk about more or less competition in credit markets without making a separate analysis of each loan product. Third, absolute estimates of market power and welfare losses can be as low as half when the Lerner index is computed from the risk-adjusted marginal opportunity cost of the loan compared with the value when it is computed using the risk-free interest rate. The effort to obtain true economic marginal costs has proven justified to avoid significant estimation biases in the calculation of welfare losses from market power.
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