The Determinants of Bank Rates in Local Consumer Lending Markets: Comparing Market and Institution-Level Results

1. IntroductionWith the exception of a few very recent studies, the sizeable literature on the impact of market structure in banking markets1 has ignored the potential competitive role played by credit unions. This is surprising, since the continuing consolidation of the financial services industry in recent years has naturally raised concerns about competitive effects and credit unions would seem to be a likely source of market discipline.2 This paper explores these issues using both market and firm data.Using a variety of approaches, economists have started paying some attention to the interaction between banks and credit unions. Emmons and Schmid (2000), using county-level data, examine twoway intertemporal linkages between credit union participation rates and market concentration of the commercial banking sector to support the view that the two types of institutions compete in the market for consumer deposits; similarly, Feinberg and Rahman (2001) find that credit union and bank rates for two consumer loan products can each be shown to be influenced by the other. Tokle and Tokle (2000) found a competitive influence of credit unions on bank certificate of deposit (CD) rates offered in Idaho and Montana, while Feinberg (2001) explored their impact on consumer loan rates in a broader sample of relatively small local markets3 over the 1992-1997 period.The latter article found that both unsecured and new vehicle loan rates offered by banks in these markets were affected in a significant manner by the market share held by the two leading banks (implying a competitive role for smaller financial institutions generally) and-for new vehicle loan rates alone-by the share of credit unions in those markets. Whether these results would generalize to larger metropolitan areas is unclear and is the topic of what follows. I focus on the same two loan products, 24-month unsecured (non-credit card) loans and 48-month new vehicle loans, both of which seem likely to be provided in a local market, and empirically explain the determinants of bank loan rates in a sample of 56 markets-both large and small-for the period 1992-1998. An innovative aspect of this paper is that I analyze both market-level data and institution-level data for 81 banks in those 56 markets and consider as well the role of multimarket linkages affecting these banks.2. Theoretical FrameworkVirtually all models of imperfect competition imply that increasing entry and supply from fringe suppliers will lower prices. This clearly suggests that an increasing credit union presence should discipline prices in local financial services markets. To formalize, I employ a modified version of the dominant firm-price leadership model. The modification involves the notion that while credit unions may generally be thought of as fringe suppliers, not all banks and savings and loans (SL (ii) as CU increases the LI declines; (iii) as [epsilon]^sub CU^ increases the LI declines; and, not quite as obvious (but easy to derive), (iv) the declines in (ii) and (iii) are larger in absolute value as CR2 is larger. …