Distance, Lending Relationships, and Competition

A recent string of theoretical papers has highlighted the importance of geographical distance in explaining loan rates for small firms.Lenders located in the vicinity of small firms face significantly lower transportation and monitoring costs, and hence wield considerable market power, if competing financiers are located relatively far from the borrowing firms.We study the effect on loan conditions of geographical distance between firms, the lending bank, and all other banks in the vicinity.For our study we employ detailed contract information from more than 15,000 bank loans to small firms comprising the entire loan portfolio of a large Belgian bank.We control for relevant relationship, loan contract, bank branch, firm, and regional characteristics.We report the first comprehensive evidence on the occurrence of spatial price discrimination in bank lending.Loan rates decrease with the distance between the firm and the lending bank and similarly increase with the distance between the firm and competing banks.The effect of distance on the loan rate is statistically significant and economically relevant.Robust to changes in model specifications and variable definitions, the effect is seemingly not driven by the modest changes over time in lending technology that we infer.We deduce that transportation costs cause the spatial price discrimination we observe.