The Dark Side of Decentralized Banks: Market Power and Credit Rationing in SME Lending

Using loan-level data from Mexico, we study the relationship between the organizational structure of banks and the terms of lending to small businesses. We find that banks with decentralized lending structures – where branch managers have autonomy over the terms of lending – give larger loans to small firms and those with more "soft information". However, decentralized banks are also more responsive to the competitive environment when setting loan terms. They are more likely to cherry pick customers and restrict credit when they have market power, even more so to smaller firms that have fewer outside options for external finance. These findings highlight a ‘darker side’ to decentralized banks and suggest that the relative benefit of a decentralized bank structure for small business lending depends critically on the nature of the competitive environment in which banks are located. JEL Classification: G21, H81, L22, L26.