Banks’ Pricing of Risk Associated with Corporate Lending

Abstract

If a bank on average prices its loans too low in relation to the risk associated with the loans, the bank’s financial strength will deteriorate over time. Banks’ pricing of risk is therefore important to the stability of the financial system. The pricing of loans also has an impact on the allocation of capital in the economy. In this article, we attempt to analyse the degree of risk pricing of loans to Norwegian limited companies. We look at the relationship between an estimated corporate borrowing rate and a bankruptcy risk measure, both calculated on the basis of the annual accounts of a large selection of enterprises for the period 1989-2001. The results indicate that the degree of risk pricing has increased during the period. The interest rate offered to high-risk enterprises is on average somewhat lower than we would expect if the rate does not have a retroactive effect on the risk of bankruptcy. We argue that this may be attributed partly to the effects of asymmetric information in the credit market.