The impact of interest rate liberalization on loan pricing efficiency: Theory and evidence

Wen Chen, Guangzi Li and Jianxiong Liu

International Review of Financial Analysis, 2025, vol. 103, issue C

Abstract: Based on the concepts of transaction and relationship loans, we derive a loan pricing model under interest rate regulation and analyze the effect of removing the cap and the floor in interest rate regulations on loan pricing efficiency. Our model shows that the impact on loan pricing efficiency of lifting the cap on loan interest rates is not definite, whereas removing the floor on loan interest rates significantly improves loan pricing efficiency. An important mechanism for improving loan pricing efficiency by removing the floor is that this change has encouraged more borrowers to shift from relationship loans to transaction loans, thereby reducing the banks' monopoly pricing power over borrowers. Our empirical analyses using a sample of loan contracts at Chinese listed firms around the time of interest rate deregulation support the model predictions. Collectively, our results suggest that liberalization of interest rate caps increases demand for relationship loans and thus might or might not increase loan pricing efficiency, depending on the monopoly power of banks. Our findings contribute to the policy of liberation interest rate regulation.

Keywords: Interest rate liberalization; Loan pricing efficiency; Relationship loans; Transaction loans (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:103:y:2025:i:c:s1057521925002947

DOI: 10.1016/j.irfa.2025.104207

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