EXPLOITING OLD CUSTOMERS AND ATTRACTING NEW ONES: THE CASE OF BANK DEPOSIT PRICING. Santiago Carbo-Valverde * Timothy H. Hannan **

Transcription

1 1 EXPLOITING OLD CUSTOMERS AND ATTRACTING NEW ONES: THE CASE OF BANK DEPOSIT PRICING Saniago CarboValverde * Tiohy H. Hannan ** Francisco RodriguezFernandez *** Absrac: Econoic heory has idenified swiching coss as poenially iporan facor in explaining he pricing of producs or services. Applied o he banking indusry, recen heoreical conribuions sugges ha deposi ineres raes should be ore aracive o cusoers in areas characerized by greaer inigraion and should be less aracive o cusoers of banks ha have greaer nubers of lockedin deposiors. Epirical evidence on he firs o hese proposiions has been quie liied, and on he second of hese poins i has been nonexisen. In his paper, we seek o es boh of hese proposiions by using daa ha allow as o disinguish beween a bank s new deposiors and hose ha ay be regarded as locked in. To obain ore efficien esiaes, our epirical es enails join esiaion of an equaion explaining he exen o which banks generae new deposi accouns and an equaion explaining deposi raes. The analysis is applied o a rich daa se obained for he Spanish banking indusry. Resuls confir ha, all else equal, banks offer higher deposi raes in erriories characerized by greaer inigraion, and also ha hey end o offer lower raes, he larger he nuber of heir lockedin deposiors. * Universiy of Granada and Federal Reserve Bank of Chicago ** Federal Reserve Board *** Universiy of Granada The views expressed in his paper are hose of he auhors and do no necessarily reflec he views of he Federal Reserve Syse or is saff.

2 2 1. Inroducion For any producs and services, consuers who have purchased fro one fir incur coss (eiher real or psychic) if hey swich o he producs or services of anoher, and i has long been recognized ha such swiching coss can have iporan iplicaions for he pricing of producs or services. The naure of hose iplicaions has been he subjec of a vas heoreical lieraure, bu sudies ha seek o apply daa o he issue of fir behavior in he presence of swiching coss have been uch rarer. Recenly, a few sudies os of he using daa fro he Unied Saes banking indusry have sough o es he pricing iplicaions of swiching coss by exploiing he following idenifying assupion: while exising cusoers incur swiching coss o change accouns fro one bank o anoher, inigrans ino an area do no face (or are less likely o face) swiching coss relevan o heir choice of bank. This assupion, cobined wih he presupion ha cusoers require soe local access o he branches of a bank, yields, aong oher hings, he esable iplicaion ha prices should be ore aracive o cusoers in areas characerized by greaer inigraion. Three sudies repor evidence consisen wih his iplicaion of swiching coss. The firs, by Sharpe (1997), eployed daa on deposis raes offered by 222 U.S. banks in he early 1980s, ogeher wih daa on he proporion of new overs in each of 105 eropolian areas as calculaed fro an earlier period and exrapolaed o he 1980s. Using a pooled ie series of 5 annual cross secions (and adjusing for ie effecs), Sharpe found ha, consisen wih predicions, he proporion of household igraion in a eropolian area has a posiive (procopeiive) effec on deposi raes, all else equal. Since deposi raes are paid o cusoers raher han by cusoers, his is equivalen o a

3 3 finding of lower prices in areas characerized by greaer inigraion, in he ore ypical case in which he price is paid by he cusoer o he fir. Hannan, e. al., (2003) also eployed a easure of igraion in heir invesigaion of he decision by U.S. banks o levy a surcharge for he use of heir auoaed eller achines (ATMs) by nondeposiors. Alhough no he priary focus of heir paper, hey repor ha banks in local arkes wih higher levels of inigraion are ore likely o ipose a surcharge a finding consisen wih he hypohesis ha ATM surcharges, because hey can arac raher han repel new deposiors, 1 are ore likely o be iposed in areas where a greaer proporion of he populaion can be ore readily araced. A uch larger sudy ha is ore focused on he relaionship beween inigraion (as well as ouigraion) and bank pricing was repored recenly by Hannan (2008). Using a saple of over 13,000 U.S. banks observed annually fro , Hannan finds ha banks end o offer higher deposi raes in areas and a ies characerized by greaer inigraion. Hannan also repors ha banks end o offer lower deposi raes in areas and a ies characerized by greaer ouigraion, all else equal a finding consisen wih he hypohesis ha banks find i in heir ineres o offer less aracive deposi raes o arac new deposiors, he shorer he period ha new deposiors are expeced o reain wih he bank. The effec on deposi raes of he ineracion beween inigraion and ouigraion, as iplied by his hypohesis, is also suppored by he resuls. 1 The reason is ha deposiors ypically do no pay surcharges for he use of heir own bank s ATMs, aking i ore desirable o open an accoun a a bank wih any ATMs if i is surcharging.

4 4 There are also epirical sudies dealing direcly or indirecly wih easures of swiching coss. Ki e al. (2003) explore he ipac of swiching coss on he Norwegian banking indusry fro 1988 o The epirical esiaions of swiching coss are derived fro a uliperiod odel of cusoers ransiion probabiliies. This odel also indirecly esiaes a lockin effec as he esiaed ipac of he 1 arke share on he fir s curren arke share. The resuls sugges ha ore han a quarer of he cusoer s added value is aribued o he lockin phenoenon generaed by swiching coss. Oher sudies have only indirecly offered soe evidence on he relevance of swiching coss on relaed areas such as payen syses. Ausubel (1991) provides soe inforaion ha swiching coss ay explain he high ineres raes on credi card balances, and Sango (2002), using variables relaed o swiching, finds ha swiching coss have a significan ipac on pricing in ha arke. In his paper, we derive fro heory and es he pricing iplicaions of swiching coss using daa applying o he Spanish banking indusry. We clai several conribuions ha se fro his effor. I is he firs sudy o esiae he relaionship beween prices and he exen of inigraion in he case of firs ouside of he U.S. banking indusry. More iporanly, daa available for he Spanish banking indusry (and no for he U.S. banking indusry) allow us o go uch furher in esing soe of he pricing iplicaions of swiching coss. The priary reason is ha daa rouinely repored for Spanish banks disinguishes beween new and old deposi accouns. This eans ha a fundaenal predicion of ore recen conribuions o he heory of swiching coss ha firs wih a larger nuber of lockedin cusoers, all else equal, charge higher prices can for he firs ie be explicily esed. As discussed in ore

5 5 deail below, i also eans ha underlying relaionships can be ore efficienly esiaed, since an equaion explaining he exen o which banks generae new accoun can be esiaed along wih a price equaion o obain ore precision in underlying esiaes. The plan of he paper is as follows: Secion 2 describes he heory eployed and derives he pricing iplicaions of swiching coss o be esed. Secion 3 presens he epirical odel and discusses issues of esiaion. Secion 4 describes he Spanish daa, while secion 5 presens esiaion resuls. A final secion concludes. Consisen wih predicions, we find srong evidence ha, all else equal, banks locaed disproporionaely in areas wih greaer levels of inigraion offer higher deposi raes, and banks wih greaer nubers of locked in deposiors offer lower deposi raes. 2. The Theory The heoreical lieraure on swiching coss is vas, and we refer he reader o Kleperer (1995) and Farrell and Kleperer (2006) for exensive reviews of i. A coon feaure of his lieraure has been he woperiod odel, wherein cusoers are locked in during he second period, and firs coplee o arac he during he firs period. While he woperiod assupion has proved o be useful in analyzing cerain quesions relevan o fir pricing, i is less useful for analyzing copeiion over any periods when new cusoers are enering he arke in every period, soe old cusoers are leaving, and firs are unable o discriinae beween new and old cusoers. Because he epirical environen ha we wish o explore conains all hree of hese

6 6 eleens, we will eploy as a frae of reference in his paper a uliperiod odel of copeiion and swiching coss presened in Beggs and Kleperer (1992). Our applicaion of his odel o he banking indusry proceeds as follows: In he h period of he uliperiod odel, assue iniially ha bank i operaes only in local arke and prices o axiize oal discouned fuure profis, represened by V = ( r r )[ x + new Z ( r, r,.)] + δv [ ρ ( x + new Z ( r, r,.))] (1) + 1, + 1 i s d. i i i d, i d, j i i i d, i d, j where V denoes he discouned fuure profis of bank i a ie, r denoes he rae ha i s banks can earn a ie by invesing deposi funds in securiies, r d, i denoes he rae ha bank i offers deposiors for deposis a ie, r d, j denoes he deposi rae offered by rival bank j, x i denoes he nuber of fir i s lockedin deposiors in arke a ie, each of which is assued o have one uni of deposis per period, new represens he nuber, 1 of new cusoers enering he arke a period, ρ + represens he proporion of deposiors in he arke a period ha survive o period +1, δ denoes a discoun facor, defined as he reciprocal of 1 plus he discoun rae, and Z (,, i rd i r d, j,.) represens bank i s share of arke s new cusoers, assued o be a posiive funcion of bank i s deposi rae, a negaive funcion of rival bank j s deposi rae, and poenially a funcion of oher characerisics, o be discussed below. For sipliciy, we do no odel he bank s loan pricing decision. We assue insead ha banks hold soe securiies in heir porfolios and ha hese are perfecly elasically supplied. This coon assupion eans ha boh deposi raes and loan

7 7 raes are deerined in par by he exogenous securiy rae, and ha deposi pricing and loan pricing can be reaed as separable. 2 The firs er on he righhand side of (1) represens curren period profis, defined as he gain earned on a uni of deposis, ( rs rd, i ), uliplied by he nuber of deposiors (each wih one uni of deposis). The nuber of deposiors is divided beween lockedin deposiors ( x i ) and he nuber of new deposiors choosing bank i a ie, or i d, i d, j new Z ( r, r,.), he nuber of new cusoers oving ino he arke, uliplied by share of he ha choose bank i. The second er in (1) reflecs he discouned value of fuure profis a ie +1, V i + 1, which is a funcion of he nuber of cusoers ha becoe locked in a ie (including new deposiors araced a ie ), uliplied by, ρ +, he proporion of deposiors in arke ha survive o ie +1., 1 To ake he odel ore relevan o an epirical exainaion, we us consider in ore deail he deerinans of he share of new cusoers ha choose bank i, as express by Z (,, i rd i rd, j,.) above. To ake heir odel racable, Beggs and Kleperer (1992) assue wo firs ha face each oher a he opposie ends of a uniforly populaed line. This iplies ha, beyond he prices ha firs charge, a large fir has no advanage over a sall one in aracing new cusoers. This is probably no rue for os indusries, and i would cerainly no be rue of he banking indusry, where he os observable, and probably os iporan, disincion beween large and sall firs is he greaer nuber of branch locaion offered by larger firs. To accoun for his issue, we will redefine (,, i d i d, j,.) Z r r as Z = brshare g ( r, r ) (2) i i i d, i d, j 2 See Klein (1971) for a fuller discussion.

8 8 where brshare i represens bank i s share of oal branches in arke a ie, and g ( r, r ), which ay be hough of as he raio of new cusoer share o branch share i d, i d, j in arke, is soe funcion ha is increasing in bank i s deposi rae and decreasing in rival bank j s deposi rae. This reaen assues (quie plausibly, in our opinion) ha, given deposi raes, he share of new cusoers ha open accouns a bank i rises proporionaely wih he bank s share of branch locaions in he arke. Subsiuions of (2) ino (1) and differeniaion wih respec o r d, i yields he firsorder condiion: g g x + ( brshare new )[ g ( r, r,.) + ( r r ) ] + V (.) ( brshare new ) = 0 i i ', 1 i i i i d, i d, j s d, i δ 1 ρ + + i rd, i rd, i. (3) This condiion iplies ha he loss in currenperiod profis resuling fro a one uni increase in he deposi rae offered lockedin deposior, x i, us equae wih he su of he currenperiod gain fro aracing new deposiors (he second er in (3)) and he gain in discouned fuure profis ha resuls fro aracing new deposiors in he curren period (he hird er in (3)). 3 Given secondorder condiions for axiizaion, i follows ha an exogenous increase in he nuber of lockedin cusoers ( x i ) will cause opial deposi raes o decline, as he radeoff beween exploiing lockedin cusoers and aracing new ones shifs in favor of exploiing lockedin cusoers, 4 while an exogenous increase bank i s araciveness o new cusoers as a resul of locaion ( brshare new ) would cause an 3 Assuing ha he discouned value of fuure profis a ie +1 is increasing in he nuber of deposiors ' a ie +1, or V (.) >, he hird er is posiive. The second er is posiive if he er in brackes, which is in essence period 1 arginal revenue, is posiive. 4 In he ineres of sipliciy, foral coparaive saics are no presened. This ay be seen by noing ha, wih an increase in x i, he expression on he lefhand side becoes ore negaive, requiring a reducion in bank i s deposi rae o resore i o zero.

9 9 opial increase in deposi raes, as his radeoff shifs in favor of aracing new cusoers. Siilar reasoning iplies ha an increase in he securiy rae ( r s ), an increase, 1 in he proporion of deposiors in arke ha survive o ie +1, ρ +, and an increase in he discoun facor ( δ ) all resul in an increase in bank i s opial deposi rae. While (3) refers o he case in which bank i operaes only in one arke, os coercial and savings banks in Spain operae in nuerous areas ha we will call arkes. For such firs, daa on deposi raes and he nuber of lockedin cusoers canno be deerined for individual arkes, aking an aggregaion across arkes necessary. Because of his, we revise (1) o accoun explicily for he suaion of profis earned in all he arkes in which bank i operaes: (1 ) V = ( r r ) [ x + new Z ( r, r,.)] + δv ( [ ρ ( x + new Z ( r, r,.))]) + 1, + 1 i s d. i i i d, i d, j i i i d, i d, j There is srong evidence ha such banks end o offer he sae deposi raes in all he areas in which hey operae. 5 This being he case, we posi ha his unifor deposi rae is chosen o axiize (1 ), yielding he revised firsorder condiion: g g x + ( brshare new )[ g ( r, r,.) + ( r r ) + V (.) ] = 0 (3 ) i i', 1 i i i i d, i d, j s d, i δ 1 ρ + + rd, i rd, i Noe ha since x = x, i is defined as he nuber of lockedin cusoers of he bank i i as a whole, raher han he nuber residing in a specific arke. If he expression in brackes does no differ arkedly across he arkes in which bank i operaes, hen he expression brsharenew can be used as a rough uliarke easure of he bank s araciveness o new cusoers as a resul of locaion. Wih no daa on he ers ha 5 This is shown, iner alia, in Jauandreu and Lorences (2002) and Carbó e al. (2003).

10 10 ake up his expression, we us assue his o be he case, wih he undersanding ha he ore his expression varies across arkes, he ore probleaic his easure will be. 6 Equaion (3 ) in paricular highlighs he ension beween he pricing iplicaions of wo aspecs of fir size. By virue of heir greaer nuber of lockedin cusoers ( x i ), one would expec larger firs o offer a higher price (lower deposi rae in his applicaion). However, by virue of he nonprice advanages ha larger firs ay have in aracing new cusoers (locaional advanages in his applicaion), one would expec larger firs o offer lower prices (higher deposi raes in his applicaion). I is ineresing o noe in his conex he predicion by Beggs and Kleperer (1992) and Kleperer (1995) ha larger firs find i in heir ineres o charge higher prices. The reason for his predicion is ha in he Beggs and Kleperer odel, larger firs differ fro saller one only wih respec o he nuber of locked in cusoers ha hey have and are assued o have no inheren advanage in aracing new cusoers. In he conex of he Spanish banking indusry, we seek o es his and oher iplicaions using epirical proxies for he nuber of locked in cusoers of banks and for he nonprice advanages ha banks have in aracing new cusoers. 3. The Tes We propose o es he pricing iplicaions of swiching coss, as derived above, by esiaing he following relaionships: 6 The issue is wheher he expression in brackes can be facored ou of he suaion, so ha he second er in (3 ) becoes [.] brshare new. I is easily shown ha he less he arkespecific values of he expression in brackes diverge fro he ean across arkes, he closer he second er in (3 ) approxiaes his funcional for.

11 11 ln( r ) = β + β ln( oldaccs ) + β ln( inigbr ) + β ln( a ) + β ln( kgdp ) + v + µ + ε, (4) d, i i i which assues a loglinear funcional for and expresses he bank s deposi rae as a funcion of he curren nuber of old accouns, denoed oldaccs, a variable calculaed as he lagged value of he of he produc of i s branch share in each arke and inigraion ino he arke, sued over all he arkes in which he bank operaes (denoed inigbr 1 ), he lagged value of he oal asses of he bank (a 1 ), and a variable indicaing he lagged value of a weighed average of he gross doesic produc of he 1 arkes in which he bank operaes (denoed kgdp 1 ). The sybol ν denoes a ie 1 1 specific fixed effec, µ denoes a bankspecific fixed effec, and ε i denoes an idiosyncraic error er. The nuber of old accouns of he bank (oldaccs) is designed o proxy he nuber of lockedin cusoers (denoed x i above), while inigbr is he easure of brshare new, defined above. The above consideraions yield he predicions: β 1 < 0 and β 2 >0. Noe fro (4) ha, because differences in bank size can be associaed wih differences in deposi raes for reasons unrelaed o he nuber of lockedin cusoers or locaional advanage in aracing new deposiors, a variable easuring he banks oal asses is included o accoun for he collecive influence of hese oher sizerelaed consideraions. The easure of arke gross doesic produc (kgdp) is also included o accoun for differences in produc deand and arke size over ie. An advanage of he daa se o be eployed is ha i also indicaes he nuber of new accouns ha he bank has araced in a curren period of ie. We have assued ha he share of new deposiors ha a bank i obains in arke ay be expressed as

12 12 Z = brshare g ( r, r ). Muliplying his by he nuber new deposiors igraing ino i i i d, i d, j arke and hen suing over all he arkes in which bank i operaes yields =, newaccs new brshare g ( r, r ) i i i d, i d, j where newaccs i denoes he nuber of new accouns obained by bank i a ie. We again propose o eploy he expression new brshare i as a separae variable under he assupion ha arkespecific values of g ( r,, r, ) do no differ oo arkedly across i d i d j he arkes in which bank i operaes. Assuing a log linear funcional for, we propose o esiae his relaionship as ln( newaccs ) = α + α ln( inigbr ) + α ln( r / r ) + v + µ + ε, (5) i d, i d, j i i where ν denoes a iespecific fixed effec, µ denoes a bankspecific fixed effec, ε i denoes an idiosyncraic error er, and all oher ers are as previously defined. Noe ha in his esiaing equaion, explanaory variables are lagged because, in he daa o be eployed, accouns are designaed as new several onhs afer hey are booked. Because he nuber of new accouns obained by a bank should increase wih greaer represenaion of he bank in arkes ha experience greaer inigraion, increase wih he bank s deposi rae, and decrease wih he deposi raes offered by rivals, i follows ha α 1 > 0 and α 2 > 0. Two ain caveas deerine he selecion of our esiaion ehod. Firs, endogeneiy is a poenial concern in esiaing hese equaions, paricularly in he case of equaion (5), which regresses a quaniy, newaccs i, on, aong oher hings, he price of ha quaniy. Secondly, crossequaion relaionships are presen, since he log of deposis

13 13 ineres raes, ln( r d, j) eners equaion (4) as a dependen variable and also eners equaion (5) as an explanaory facor wihin he er ln( rd, i / r d, j ). To obain efficien esiaes and address he issue of endogeneiy, we propose o esiae (4) and (5) joinly using 3sage leas squares (3SLS) wih fixed effecs and ie duies. Wih he excepion of ln(oldaccs ), which by definiion reflecs decisions ade prior o ie, all explanaory variables in (4) and (5) are lagged. Lagged values of hese explanaory variables (ie., variables lagged an addiional period) are used as insruens. Focusing for a oen on he esiaion of (4), his reaen eliinaes perhaps he os obvious source of endogeneiy, bu, as is well undersood, i does no eliinae all such sources if errors are correlaed over ie. The priary concern here is ha soe uneasurable aspec of he environen in which banks operae is associaed wih he bank s deposi raes as well as he variables easuring he nuber of old accouns and he exen of igraion ino he arkes in which he bank operaes. Our priary defense is o include arkespecific easures which conrol for hose oherwise uneasurable aspecs of he change in arkes over ie. The easure of lagged arke gross doesic produc (gdp 1 ) is included in equaion (4) for ha purpose. We have also included easures of arke populaion, populaion densiy, percenage of urban populaion, oal eployen, and regional uneployen raes (no repored) wih no aerial difference o he resuls repored below. In assessing he poenial for endogeneiy in he esiaes of (5), he priary concern is ha uneasurable characerisics of he arke or bank are associaed wih he nuber of new accouns ha a bank is able o arac, as well as wih is deposi rae relaive o he deposi raes of is rivals or wih he exen of inigraion ino he arkes

14 14 in which he bank operaes. In addiion o using an addiional lag of he explanaory values as insruens, we also eploy as insruens in esiaing (5) he oal asses of he bank, he average gross doesic produc of he arkes in which he bank operaes, and he raio of he size of he bank o he average size of he banks ha operae in he sae arkes as he bank. The 3SLS procedure is a cobinaion of a wosage leas squares (2SLS) and a seeinglyunrelaed regression (SUR esiaion). In he firs sage of he hreesage procedure, he endogenous variables are regressed on all he exogenous variables in he syse. In he second sage, he fied values of he endogenous variables are used o obain wosage leassquares paraeer esiaes for all equaions in he syse. In he hird sage, generalized leassquares esiaes are obained aking ino accoun crossequaion correlaion aong he disurbance ers (Zellner and Theil, 1962; Wooldridge, 2002). The objecive funcion for hree sage leas squares is he su of squared ransfored fied residuals, and he esiaes are obained by esiaing equaions (4) and (5) siulaneously wih a diagonal covariance arix of he disurbances across equaions. 4. The daa The daa consis of seiannual inforaion on 65 banks (29 coercial banks and 46 savings) banks in Spain during 1986:12003:2, resuling in a balanced panel of 2,700 observaions, less exclusions due o he use of lagged variables. These banks represen an average of 92% of oal bank asses in Spain during ha period. The daa have been obained fro balance shee, incoe saeen, and eo and repor ies

15 15 provided by he Spanish Banks Associaion (AEB) and he Spanish Savings Banks Confederaion (CECA). Daa on inigraion in he 52 provinces of Spain have been obained fro he Naional Saisical Office (INE). The ain definiions and suary saisics for variables eployed in he epirical sudy are shown in Table 1. A fundaenal presupion is ha condiions peraining o he provinces in which each bank operaes are relevan o he bank s pricing behavior and he nuber of new accouns ha i regisers. Areaspecific variables, such as he exen of iigraion and GDP, are aggregaed o he level of he bank by using he erriorial disribuion of branches of he bank as a weighing facor. Measures of he nuber of old lockedin deposiors, bank oal asses, and deposi raes, are all calculaed using daa ha apply o he bank as a whole. In he saple periods, several bank ergers ook place. In order o ge a balanced panel and o concenrae he analysis on he relaionship beween deposi raes, inigraion and lockedin cusoers, daa for erging banks correspond o a profora cobinaion of erging insiuions in he years prior o he erger. For a nuber of reasons, he Spanish banking secor provides a good laboraory for research on lockedin deposiors, iigraion and deposi ineres raes. Firs, inforaion is available on he nuber of new and old deposi accouns, and his allows us o disinguish beween new and old ( lockedin ) cusoers. Secondly, coercial and savings banks have fiercely copeed o arac new cusoers. Wih he lifing of branching resricions in 1989, which peried savings banks o open branches ouside heir original erriories, coercial and savings banks sared he socalled superaccouns price war in he deposi arke. During he 1990s and he early 2000s, i has been deonsraed ha Spanish banks priced heir deposis below heir arginal coss in

16 16 a lossleader behavior ha aied o arac new deposiors. 7 During he period, here has been a grea deal of variaion in he evoluion of ineres raes, ainly as a consequence of oneary policy decisions (including Spain s enry ino he European Moneary Union). 5. The resuls Table 1 presens variable definiions and suary saisics, while reaining ables presen econoeric resuls. As indicaed, he period fro 1986 o 2003 was one of generally declining ineres raes. Oher variables exhibied increases over he period, wih oal asses (a) showing a paricularly sharp increase. Table 2 presens econoeric resuls obained using boh wosage leas squares (2SLS) and hreesage leas squares (3SLS) for he full saple of boh coercial banks and savings banks. The second and hird coluns of able 2 repor he resuls of esiaions of equaions (4) and (5), respecively, using 3SLS, while, o assess robusness, he final wo coluns repor equivalen esiaions using 2SLS. Noe firs ha in he deposi rae regression esiaed as par of he 3SLS esiaion and presened in he second colun, he coefficiens of boh ln(oldaccs ) and ln(inigbr 1 ) bear he hypohesized signs and are highly significan, suggesing ha banks wih ore lockedin deposiors offer lower deposi raes and banks locaed in areas exhibiing ore inigraion offer higher deposi raes, all else equal. Coefficien agniudes sugges ha a 10 percen rise in he nuber of lockedin accouns would cause he deposi rae o decline by abou 1.2 percen, while a 10 percen increase in 7 The lossleader behaviour in deposi arkes is a coon feaure of he EU banking secors in he las wo decades (Maudos and Fernández de Guevara, 2007).

17 17 inigbr 1 would cause he deposi rae o increase by abou 1.8 percen. The coefficien of he log of oal asses, ln(a 1 ), is also posiive and highly significan, iplying ha unidenified aspecs of bank size no associaed wih he nuber of lockedin deposis or he bank`s locaional araciveness for inigrans are on average posiively associaed wih he bank s deposi rae. The coefficien of he log of arke GDP, ln(kgdp 1 ), is negaive and highly significan, perhaps because an increase in arke GDP indexes he supply of deposi Euros o local banking insiuions. Coefficiens in he new accouns regressions, esiaed wih 3SLS and presened in he hird colun, also bear he hypohesized signs and are highly significan. Coefficien agniudes sugges ha a 10 percen increase in inigbr 1, he variable indicaing he araciveness of he bank o inigraing cusoers for reasons of locaion, is associaed wih a 2.4 percen increase in he nuber of new accouns, while a 10 percen increase in he raio of a bank s own deposi rae o ha of is rivals would be associaed wih a 10 percen increase in he nuber of new accouns araced o he bank. Thus i appears ha he predicions of he odel are validaed by he observed coefficiens in he new accouns equaion. Our priary ineres, however, ceners on he coefficiens of ln(oldaccs ) and ln(inigbr 1 ) in he deposi rae equaion, since hey relae o he hypohesized roles of lockedin cusoers and locaional araciveness o new cusoers in deerining he deposi raes ha banks choose o offer. The final wo coluns in able 2 presen he resuls of esiaions obained using 2SLS raher han 3SLS. As ay be seen, resuls are siilar. Resuls are qualiaively siilar o hose obained using 3SLS. I is ineresing o noe, however, ha, especially in he case of he coefficiens of priary ineres, agniudes end o be soewha larger,

18 18 and sandard errors end o be soewha saller, in he case of he 3SLS esiaions, suggesing ha i is of soe iporance o accoun for covariances across equaion disurbances. Because he full saple is coposed of boh coercial banks and savings banks, able 3 repors 3SLS resuls obained separaely for each ype of insiuion. As indicaed, coefficiens bear he prediced signs and are saisically significan for boh coercial banks and savings banks. Coefficien agniudes, however, end o be saller in he case of savings banks. This difference ay be due o he fac ha savings banks operae, on average, in fewer provinces. Thus hey ay no always be able o exploi inigraion advanages as os coercial banks do. In an alernaive breakdown of he saple, able 4 repors 3SLS resuls obained for each of wo subsaples, one applying o all banks he period and he oher applying o all banks for he period For boh subsaples, he coefficiens of priary ineres bear he hypohesized signs and are highly significan. Coefficien agniudes, however, are differen in he case of ln(oldaccs ) and ln(inigbr 1 ), In he radeoff beween exploiing old cusoers and aracing new ones, as expressed by hese coefficiens, capuring new cusoers appears o have aken on greaer weigh in he laer period. This ay be relaed o he fac ha he laer period was one of subsanially greaer inigraion, causing ore banks o consider he iplicaions of inigraion in heir pricing decisions. In a final breakdown, able 5 presens resuls obained for hose insiuions ha operae in less han 10 provinces, 10 o 25 provinces, and in ore han 25 provinces. This breakdown closely corresponds o a breakdown by size below and over he edian

19 19 oal asses (no shown). Again, he coefficiens of ineres bear he hypohesized signs and are saisically significan in all hree subsaples. A raher sark difference in coefficien agniudes appears in he coefficien of ln(inigbr 1 ) in he new accouns equaion. The nuber of new accouns appears o be uch ore responsive o changes in inigraion for larger banks operaing in ore provinces. A possible explanaion for hese differences in ha larger banks operaing in ore provinces enjoy a wider range of choices for locaion and herefore a higher probabiliy of being locaed in he provinces where inigraion offers ore opporuniies o banks. Anoher possible explanaion is ha sall banks operaing in few provinces ay benefi fro inforaional privileges on heir borrowers, and ha he value of he inforaional privilege is inversely relaed o he value of swiching coss, as suggesed by Vesala (2007). 6. Conclusions In his paper, we have derived and esed he pricing iplicaions of swiching coss using daa fro he Spanish banking indusry. Of he wo findings ha we consider os iporan, one confirs resuls repored previously by researchers using daa fro he US banking indusry, and one confirs resuls prediced in he lieraure bu, o our knowledge, never before subjeced o epirical esing. Firs, we find srong evidence ha banks locaed disproporionaely in areas wih high levels of inigraion offer higher deposi raes, all else equal. Second, and unique o his sudy, we find ha banks wih ore lockedin cusoers offer lower deposi raes, all else equal. These wo findings confir he exisence of he radeoff uch ephasized in recen heories of pricing in he presence of swiching coss he radeoff beween exploiing old cusoers

20 20 and aracing new ones. This radeoff iplies ha banks locaed in area wih uch inigraion and ha have fewer lockedin deposiors will end o offer higher raes, while banks no locaed in areas wih subsanial inigraion and ha have ore lockedin cusoers will offer lower deposi raes. Because he Spanish banking daa allows us o disinguish beween new and old deposi accouns, we also esiae he relaionship beween new accoun foraion and is deerinans, and here oo we find resuls consisen wih predicions. By esiaing he resuling woequaion epirical odel using hreesage leas squares, and hereby accouning for correlaion of errors across equaions, we repor greaer precision in os coefficien esiaes han ha obained wih siple wosage leas squares.. References Ausubel, L. (1991) The failure of copeiion in he credi card arke, The Aerican Econoic Review 81, Beggs, A. and Kleperer, P. (1992), Muliperiod Copeiion wih Swiching Coss, Econoerica 60: Carbó, S., Huphrey, D. and F. Rodríguez (2003), Deregulaion, bank copeiion and regional growh, Regional Sudies 37: Hannan, T. H. (2008), Consuer Swiching Coss and Fir Pricing: Evidence fro Bank Pricing of Deposi Accouns, FEDS working paper , Federal Reserve Board. Hannan, T. H., Kiser, E. K., Prager, R.A. and J. J. McAndrews (2003), To Surcharge or no o Surcharge: An Epirical Exainaion of ATM Pricing, Review of Econoics and Saisics 85(4): Jauandreu, J. and J. Lorences (2002), Modeling price copeiion under produc differenciaion and any firs (an applicaion o he Spanish loans arke), European Econoic Review, 46:93115.

21 21 Ki, M. Kliger, D. and B. Vale (2003), Esiaing swiching coss: he case of banking, Journal of Financial Inerediaion, 12: Kleperer, P. (1995), Copeiion when Consuers have Swiching Coss: An Overview wih Applicaions o Indusrial Organizaion, Macroeconoics, and Inernaional Trade, Review of Econoic Sudies 62: Maudos, J. and J. Fernandez de Guevara (2007), The cos of arke power in banking: Social welfare loss vs. cos inefficiency, Journal of Banking & Finance 31: Sharpe, S. A. (1997), The Effec of Consuer Swiching Coss o Prices: A Theory and is Applicaion o he Bank Deposi Marke, Review of Indusrial Organizaion 12: Sango, V. (2002), Pricing wih Consuer Swiching Coss: Evidence fro he Credi Card Marke, Journal of Indusrial Econoics 50: Vesala, T. (2007), Swiching coss and relaionship profis in bank lending, Journal of Banking and Finance, 31: Wooldridge, J.M., (2002), Econoeric analysis of cross secion and panel daa. Massachuses Insiue of Technology Press, Cabridge, MA. Zellner, A. and Theil, H., Threesage leas squares: siulaneous esiaion of siulaneous equaions. Econoerica, 30 (1), 5478.

22 22 Table 1. Variable definiion and suary saisics Variable Mean Sd. Dev. r d, i newaccs 23,126 29,491 30,250 27,303 31,891 33,977 29,340 4,920 oldaccs 672, , , , , , ,668 93,139 inigbr 31,126 36,505 43,344 53,280 63,242 75,619 50,519 15,726.7 a 2,035,643 3,525,126 5,695,663 7,434,062 10,266,125 14,403,233 7,226,643 4,234,103 ln( kgdp 1 ) Deposi rae ha bank i offers deposiors for deposis a ie. Deposi ineres raes are copued as ineres expenses r d, i divided by oal deposis. Deposi rae offered by rival bank j for deposis a ie. The rivals deposis have been copued as an average of he r d, j rivals deposi raes in he provinces where he banks operae using he branches disribuion of he bank in hose erriories as a weighing facor. newaccs Toal nuber of new deposi accouns opened in period. oldaccs Toal nuber of old deposi accouns ( lockin cusoers) in period. inigbr a ln( kgdp 1 ) A relaive easure of inigraion, calculaed as he he suaion across all he arkes in which a bank operaes of he produc of i s branch share in each arke and inigraion (new populaion) ino he arke in period. Toal asses, a proxy for bank size. Logarih of arke GDP in real ers, copued as an average of he GDP in he provinces where he banks operae using he branches disribuion of he bank in hose erriories as a weighing facor.

23 23 Table 2. Siulaneous equaions resuls. All banks Bank level fixed and ie effecs included in all he equaions (esiaes for he ie duies no shown for sipliciy) Sandard errors (clusered a he fir level) in parenhesis All banks (3SLS) All banks (2SLS) Dependen Variable ln( d, i ) β 0 ln( oldaccs ) ln( inigbr ) ln( a ) 1 1 ln( kgdp ) 1 r ln( newaccs ) ln( r d, i ) ln( newaccs ) 0.001*** 0.121*** (0.021) 0.176*** (0.035) 0.078*** (0.017) 1.457*** (0.048) 0.001** 0.108* (0.024) 0.164** (0.045) 0.081** (0.019) 1.469* (0.044) α ln( inigbr 1) 0.236** 0.213* (0.099) (0.104) 1.055*** 1.055*** ln( rd, i / r d, j ) (0.129) (0.117) R χ *** 721.1*** n. observaions 2,400 2,400 2,400 2,400 *** Indicaes pvalue of 1% ** Indicaes pvalue of 5%

24 24 Table 3. Three sage leas squares resuls. Coercial and savings banks. Siulaneous equaions esiaion Bank level fixed and ie effecs included in all he equaions (esiaes for he ie duies no shown for sipliciy) Sandard errors (clusered a he fir level) in parenhesis Coercial banks Savings banks Dependen Variable ln( d, i ) β 0 ln( oldaccs ) ln( inigbr ) ln( a ) 1 1 ln( kgdp ) 1 r ln( newaccs ) ln( r d, i ) ln( newaccs ) 0.001*** 0.106*** (0.031) 0.381*** (0.035) 0.024*** (0.017) 1.114*** (0.108) 0.001** 0.042* (0.035) 0.174** (0.045) 0.021** (0.031) 1.645*** (0.052) α 0.001** 0.001** 0 ln( inigbr 1) 1.002*** 0.518* (0.181) (0.103) ln( rd, i / r d, j ) 1.270*** 0.267*** (0.115) (0.121) R χ *** *** n. observaions ,472 1,472 *** Indicaes pvalue of 1% ** Indicaes pvalue of 5%

25 25 Table 4. Threesage leas squares resuls. Breakdown for and Bank level fixed and ie effecs included in all he equaions (esiaes for he ie duies no shown for sipliciy) Sandard errors (clusered a he fir level) in parenhesis Dependen Variable ln( d, i ) β 0 ln( oldaccs ) ln( inigbr ) ln( a ) 1 1 ln( kgdp ) 1 r ln( newaccs ) ln( r d, i ) ln( newaccs ) 0.001*** 0.248*** (0.024) 0.151*** (0.032) 0.084*** (0.018) 1.479*** (0.051) 0.001* 0.102*** (0.021) 0.294*** (0.047) 0.075** (0.019) 1.433** (0.047) α ln( inigbr 1) 0.201** 0.213* (0.094) (0.104) 1.051*** 1.055*** ln( rd, i / r d, j ) (0.127) (0.117) R χ *** 886.7*** n. observaions 1,120 1,120 1,280 1,280 *** Indicaes pvalue of 1% ** Indicaes pvalue of 5%

26 26 Dependen Variable ln( d, i ) β 0 ln( oldaccs ) ln( inigbr ) ln( a ) 1 1 ln( kgdp ) 1 Table 5. Three sage leas squares resuls. Siulaneous equaions esiaion Bank level fixed and ie effecs included in all he equaions (esiaes for he ie duies are no shown for sipliciy) Sandard errors (clusered a he fir level) in parenhesis Banks operaing in less han 10 provinces Banks operaing in 1025 provinces Banks operaing in ore han 25 provinces r ln( newaccs ) ln( r d, i ) ln( newaccs ) ln( r d, i ) ln( newaccs ) 0.001*** 0.010*** (0.002) 0.022*** (0.004) 0.061** (0.002) 1.606*** (0.056) 0.001*** 0.022*** 0.064*** (0.002) 0.030*** 1.237*** (0.042) 0.001*** (0.002) 0.013*** (0.003) 1.399*** (0.013) α ln( inigbr 1) 0.035** 1.201*** (0.002) (0.016) ln( rd, i / r d, j ) 1.363*** 1.623*** (0.014) (0.014) R χ *** 195.6*** 272.1*** n. observaions 1,270 1, *** Indicaes pvalue of 1% ** Indicaes pvalue of 5% *** (0.012) 1.394*** (0.010)