Distance, Lending Technologies and Interest Rates

We investigate how the distance between banks and firms affect loan interest rates. To this aim, we use detailed information on more than 370,000 bank loans granted to firms by more than 120 Italian banking institutions (stand-alone banks and banking groups). We find that loan interest rates correlate negatively with the distance between the bank headquarters and the borrower and that the effect of distance on interest rates is lower for large banks compared to small intermediaries. This result buttresses the hypothesis that those banks whose headquarters are close to firms (local banks) are in a better position to establish close relationships with borrowers, consequently gaining an informational advantage over competitors. Thus, local banks certify the quality of borrowers and therefore charge a certification premium over loan interest rates. The analysis also suggests that a certain degree of specialization among banks may improve the efficiency of the banking system as a whole, with local banks engaging in relationship lending technology and other banks focusing on transaction lending technologies