Market discipline in Mexican banks: Evidence from the asset side

This paper studies the asset side market discipline effect in Mexico, whether borrowers pay higher interest rates (price-based mechanism) to high-quality banks, and consequently, whether borrowers discipline their banks. Borrowers continuously require credit and they choose large banks because their lending activity is trustworthy (a refinancing-solvency motive). In addition, borrowers prefer banks with lower loan losses to signal their creditworthiness to other stakeholders (a certification-signaling motive). Using a sample of 37 banks over the years 2008 to 2012 and a dynamic panel model, we found evidence in favor of these motives through a price-based mechanism, that is, the Mexican borrowers are willing to pay higher rates to larger banks with higher capital ratios and reserves for loan losses, or lower nonperforming loans. As a result, the Mexican banks face market discipline induced by borrowers, albeit this discipline is absent in retail and largest banks. (C) 2012 Asociacion Cuadernos de Economia. Published by Elsevier Espana, S.L. All rights reserved.