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Risk aversion and bank loan pricing

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  • Camba-Méndez, Gonzalo
  • Mongelli, Francesco Paolo

Abstract

How much of the heterogeneity in bank loan pricing is explained by disparities in banks’ attitude towards risk? The answer to this question is not simple because there are only very weak proxies for gauging the degree of a bank’s risk aversion. We handle this constraint by means of a novel econometric approach that allows us to disentangle the amount of risk faced by banks and the price they charge for holding that risk. Some of our results are aligned with previous studies and confirm that disparities in market power, banks’ funding costs, and banks’ funding risks are reflected in bank lending rates. However, our new modelling framework reveals that the heterogeneity in bank lending rates is also a reflection of the non-negligible disparities in banks’ risk aversion. JEL Classification: C23, E58, G21

Suggested Citation

  • Camba-Méndez, Gonzalo & Mongelli, Francesco Paolo, 2021. "Risk aversion and bank loan pricing," Working Paper Series 2514, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20212514
    Note: 1423663
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    References listed on IDEAS

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    1. Gambacorta, Leonardo, 2008. "How do banks set interest rates?," European Economic Review, Elsevier, vol. 52(5), pages 792-819, July.
    2. Altunbas, Yener & Manganelli, Simone & Marques-Ibanez, David, 2017. "Realized bank risk during the great recession," Journal of Financial Intermediation, Elsevier, vol. 32(C), pages 29-44.
    3. Holton, Sarah & Rodriguez d’Acri, Costanza, 2015. "Jagged Cliffs and Stumbling Blocks: Interest Rate Pass-through Fragmentation during the Euro Area Crisis," Research Technical Papers 01/RT/15, Central Bank of Ireland.
    4. Sealey, C W, Jr, 1980. "Deposit Rate-Setting, Risk Aversion, and the Theory of Depository Financial Intermediaries," Journal of Finance, American Finance Association, vol. 35(5), pages 1139-1154, December.
    5. Camba-Méndez, Gonzalo & Durré, Alain & Mongelli, Francesco Paolo, 2016. "Bank interest rate setting in the euro area during the Great Recession," Working Paper Series 1965, European Central Bank.
    6. Angbazo, Lazarus, 1997. "Commercial bank net interest margins, default risk, interest-rate risk, and off-balance sheet banking," Journal of Banking & Finance, Elsevier, vol. 21(1), pages 55-87, January.
    7. Koppenhaver, G D, 1985. "Bank Funding Risks, Risk Aversion, and the Choice of Futures Hedging Instrument," Journal of Finance, American Finance Association, vol. 40(1), pages 241-255, March.
    8. Ho, Thomas S. Y. & Saunders, Anthony, 1981. "The Determinants of Bank Interest Margins: Theory and Empirical Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 16(4), pages 581-600, November.
    9. Ronald A. Ratti, 1980. "Bank Attitude Toward Risk, Implicit Rates of Interest, and the Behavior of an Index of Risk Aversion for Commercial Banks," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 95(2), pages 309-331.
    10. João A. C. Santos, 2011. "Bank Corporate Loan Pricing Following the Subprime Crisis," The Review of Financial Studies, Society for Financial Studies, vol. 24(6), pages 1916-1943.
    11. Holton, Sarah & d’Acri, Costanza Rodriguez, 2015. "Jagged cliffs and stumbling blocks: interest rate pass-through fragmentation during the Euro area crisis," Working Paper Series 1850, European Central Bank.
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    Cited by:

    1. Nguyen, Thanh Cong & Thuy, Tien Ho, 2023. "Geopolitical risk and the cost of bank loans," Finance Research Letters, Elsevier, vol. 54(C).

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    More about this item

    Keywords

    bank loan pricing; risk aversion;

    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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