Switching costs in local credit markets

Switching costs are a key determinant of market performance. This paper tests their existence in the corporate loan market in which they are likely to play a central role because of the complexity of contracts and informational problems. Using very detailed data at bank-firm level on four Italian local credit markets we empirically show that firms tend to iterate their choice of the main bank over time. This inertia is not related to unobserved and time invariant preferences of firms across banks and can be attributed to the existence of switching costs. We also offer evidence that banks price discriminate between new and old borrowers by charging lower interest rates to the former in order to cover part of the switching costs. The discount is about 44 basis points, equal to 7 per cent of the average interest rate. These results prove robust to a number of other potential identification drawbacks.