The determinants of bank rates in local consumer lending markets: comparing market and institution-level results.

• Author: Feinberg, Robert M.

1. Introduction

   With the exception of a few very recent studies, the sizeable literature on the impact of market structure in banking markets (1) 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 two-way 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 Rabman (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 markets (3) 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 Framework

   Virtually 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 (S&Ls) would realistically constitute a dominant group. Nevertheless as a group we can think of banks and S&Ls as being relatively dominant, with the degree to which a monopoly position over their residual demand (i.e., netting out credit unions) is exploited depending on how concentrated bank and S&L deposits are in the leading two institutions. (4)

   The number of major firms is often quite small in local consumer lending markets, and there is a genuine concern that in the absence of pressure from a "competitive fringe" these leading firms may be able to act in a collusive manner. In the spirit of Saving (1970), I assume a homogeneous product, with market demand for loans Q = D(P). Credit unions are treated as a price-taking fringe, with their supply [S.sup.CU](P) and the demand faced by banks and S&Ls, [D.sup.B](P), a residual:

   [D.sup.B](P) = D(P) - [S.sup.CU](P). (1)

   Taking first derivatives with respect to price, multiplying all terms by (P/Q), and multiplying the lefthand side expression by ([D.sup.B](P)/[D.sup.B](P)) and the last term on the right-hand side by ([S.sup.CU](P)/[S.sup.CU](P)), I obtain

   [PD.sup.B]'(P)[D.sup.B](P)/[D.sup.B](P)D(P) = D'(P)P/D(P) - [S.sup.CU]'(P)[PS.sup.CU](P)/[S.sup.CU](P)D(P) (2)

   or, simplifying, and defining CU to be equal to [S.sup.CU](P)/D(P), the credit union market share, and then dividing through by 1 - CU, I obtain an expression in terms of price elasticities of demand and supply,

   \[[eta].sub.B]\ = \[eta]\/(1-CU) + [[epsilon].sub.CU] (CU/(1-CU)). (3)

   If I assumed that all non-credit union institutions acted to jointly maximize profits, I would of course find that their Lemer Index, LI = (P - MC)/P = 1/\[[eta].sub.B]\ . More realistically, I parameterize the extent to which the Lemer Index approaches this value as a function of dominance within the bank and S&L group of the two leading firms (to simplify, a linear function) so that

   LI = [theta]/\[[eta].sub.B]\, (4)

   where [theta] = kCR2/(1 - CU), CR2 = the share of the two largest financial institutions in total market deposits (including credit unions), k is a constant, and 0

   Substituting Equation 3 into Equation 4, I obtain the bank/thrift Lemer Index to be

   LI = kCR2/\[eta]\ + [[epsilon].sub.CU]CU. (5)

   Without any further mathematical analysis, the following implications clearly emerge: (i) As CR2 increases the LI increases as well; (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. All of the qualitative results above follow when I replace LI with the market price, which is the variable I seek to explain in the empirical work to follow.

   While obviously this model is quite ad hoc in nature, the clear implication is that bank concentration, the credit union share, and the supply elasticity of credit unions all matter in determining the exercise of market power in these markets.

3. Data

   Data on bank loan rates (5) were obtained (via a Freedom of Information Act request) from the Federal Reserve Board's Quarterly Report of Interest Rates on Selected Direct Consumer installment Loans, and on local market structure from Sheshunoff Information Services, for the 1992-1998 period. The two bank loan rates (reported for the second week of Februaiy, May, August, and November) are for 48-month new auto loans and for 24-month non-credit card unsecured consumer loans, for which banks are requested to report their most common rate. These types of loans are the only ones reported on in the Federal Reserve Board survey.

   Markets were included for which data were available on bank rates for both types of loans for at least two-thirds of the 28 quarterly observations from 1992 through 1998. I also deleted six markets in which a single credit union was among the top two depository institutions during this period (as these markets seem inconsistent with the model above in which credit unions are viewed as a competitive fringe)6 and three markets in which local market structure data were distorted by the presence of bank credit card operations. (7) This left 56 markets (listed in Appendix A), defined as metropolitan statistical areas (MSAs) or nonmetropolitan counties. (8) Of these, 52 are MSAs ranging in size (based on 1990 population figures) from Victoria (Texas)--with a population of 74,361--to the New York City consolidated MSA--with almost 20 million people. The other four are rural counties ranging in size from Atchison County (Kansas)--16,932--to Sussex County (Delaware)--1 13,229. The median 1990 population for the 56 mar kets was 674,267.

   My initial analysis was performed at the level of the market, with a simple average of loan rates of surveyed banks within that market (or if only one bank was surveyed that bank's loan rate) taken to proxy the market rate. Based on deposit data from banks, thrifts, and credit unions (collected by Sheshunoff Information Services), the share of total market deposits held by credit unions and by the top two depository institutions and (as a proxy for scale economies being exploited in the market) the absolute total of the largest institution deposits in the market were recorded for each market and time period. (9) To proxy the elasticity of supply by credit unions, data were obtained from the Credit Union National Association (CUNA) on state-level credit union membership as a percentage of adult population. The federal funds rate (obtained from Federal Reserve statistics) was employed as a proxy for the cost of funds to banks.

   Descriptive statistics for the market-level analysis are given in Table 1, which contains a breakdown by small and big markets, those below or above one million in 1990 population. Clearly, the average big market has a somewhat smaller credit union presence (7.9% vs. 9.1%) and slightly smaller top two bank share (39.6% vs. 41.4%). Not surprisingly, the largest institution is considerably bigger (averaging more...