Economic policy uncertainty and banks’ loan pricing

Using news-based government economic policy uncertainty (EPU) index of Baker et al. (2016) and bank-level data from 17 countries over the period 1998–2012, we find that government economic policy uncertainty has significant positive association with interest rates on bank gross loans. Specifically, a one standard deviation increase in EPU leads to 21.84 basis points increase in average interest rates on bank gross loans. We conjecture the economic policy uncertainty boosts banks’ loan prices by increasing the borrowers’ default risk. The impact of EPU on banks’ loan pricing remains persistent after controlling for banks’ own idiosyncratic default risk and the political risk variables from ICRG database. Results remain robust when we use general elections as an alternative proxy of government economic policy uncertainty. We also confirm main results with syndicated loan deals data and observe a significant positive association between loan spreads and EPU index. Together, our results suggest that government economic policy uncertainty is an economically important risk factor for banks’ loan pricing.