As an alternative measure of firm risk, we use the rating of the first earmarked loan issued to each firm _f_ .<sup>15</sup> We classify firm risk as an indicator variable that equals one for firms with earmarked rating below the median in that month and zero otherwise. The results are presented in Table A2 in the Appendix. Overall, we confirm that riskier firms operating in regions where the banking sector is more concentrated experienced larger increases in the price of new working capital loans. These firms pay an additional 1.84 pp in the interest rate of working capital loans, which correspond to a 6.5 percent increase relative to the mean.

# **5.6. Alternative measure of market power**

In the analysis, we refer interchangeably to market power and market concentration. That is, we identify regions where the banking industry concentration, measured by the Herfindahl Index at the 2-digit zip code, is above the median of that year. To the extent that a small number of large banks dominate these markets, they might have more power to set prices. As a robustness check, we run our baseline specifications using two alternative measures of market power and confirm that our results remain unchanged.

The first measure corresponds to the banks’ Lerner Index, which captures the lender’s ability to set prices above its marginal costs <mark>(Bikker & Haaf 2002)</mark> . As the Lerner Index uses aggregate bank balance sheet data, one limitation in our set up is that this measure is calculated at the bank-time level. Thus, we cannot exploit important heterogeneity within a lender across different locations where firms operate at a given point in time. Despite this limitation, we estimate Equation (3) defining M l as equal to one for banks with a Lerner Index above the median and zero otherwise. The results of this exercise are summarized in Panel A of Table A3 in the Appendix. We confirm the main finding: after issuing an earmarked loan, banks with more market power tend to increase the interest rate of new working capital loans to riskier borrowers. Notably, these banks do not reduce their lending volume to these firms.

Exploiting the fact that asymmetric information is a natural source for imperfect competition, we use the number of bank relationships for each firm as an alternative measure of market power. The intuition behind this measure is that a bank can extract rents for firms that are more informationally opaque because of the limited ability of these firms to find new lenders. For instance, if a bank is the sole provider of credit to a firm, it gains valuable information about the borrower’s risk through its longstanding relationship, which can be then used to extract rents from the client (Greenbaum, Kanatas, and Venezia, 1989; Sharpe, 1990; Petersen and Rajan, 1994; Bharath et al., 2007; Ioannidou and Ongena, 2010). We estimate Equation (3) defining M l as equal to one if the firm only receives credit from a single bank and zero if the firm has credit relationships with multiple banks prior to obtaining earmarked credit. The results of this check, displayed in Panel B of Table 4 in the Appendix, show that while price mark-ups in working capital loans are more pronounced for riskier firms that obtain their credit from a single bank, their loan volumes remain unchanged.

> 15 There are at least two advantages of this measure. First, banks set their loan provisions according to this rating. Thus, this variable provides useful information about the risk assessment of the firm at the exact time of its first earmarked loan. Second, different from our baseline risk variable, this measure does not require information about prior working capital loans of a firm; hence we capture more firms in the sample.

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