The association between firm fundamentals and bank interest rates under different measures of risk

This paper examines the association between elements of the financial statement and the interest rates banks charge on loans. We examine whether the volatility of earnings and the probability of bankruptcy have an impact on banks' use of accounting information in setting the interest rates. The results suggest that while these accounting variables are associated with bank interest rates, the impact of the accounting variables is stronger when the volatility is lower. We also provide evidence that the association between bank interest rates and the net book value of assets and operating income is stronger when the probability of bankruptcy is low. This relationship is opposite for the presence of a loss. When the probability of bankruptcy is high, banks appear to focus less on the income statement and more on the balance sheet. This is likely due to the fact that the balance sheet provides an estimate of the liquidation value of the firm.