Pricing restrictions and pairing effect in bank loan market

Abstract

The occurrence of "Pairing Effect" as a consequence of supply side adaptation in bank's credit in the presence of restrictive pricing has been proposed. Policy driven price restrictions leads to inadequate pricing of riskier loan structures and would result in pairing of strong banks with less risky loan structures and weak banks with more risky loan structures. The researcher tests this argument in the presence of exogenous shock based natural experimental setup of interest spread intervention 2013/14 in Nepal. The study applies Difference-In-Differences design to estimate effect of the price restrictions on different loan structures. The study documents significant increase in loan size of structures with low information asymmetry and significant decrease in loan size of structures with high information asymmetry supporting the Pairing Effect argument. The estimates are significant after allowing for firm's specific heterogeneity. The data survive placebo test identified through pseudo-shock and other robustness test that have demonstrated the inferences as non-trivial. Key words: Pricing restriction, Pairing effect, Bank loan market