WORKING PAPER SERIES
Lender-Borrower Relationships and
Loan Origination Costs
Philip Ostromogolsky
Federal Deposit Insurance Corporation
January 2017
FDIC CFR WP 2017-03
fdic.gov/cfr
NOTE: Staff working papers are preliminary materials circulated to stimulate discussion and critical
comment. The analysis, conclusions, and opinions set forth here are those of the author(s) alone and do not
necessarily reflect the views of the Federal Deposit Insurance Corporation. References in publications to this
paper (other than acknowledgement) should be cleared with the author(s) to protect the tentative character
of these papers.
Lender-Borrower Relationships and
Loan Origination Costs
Philip Ostromogolsky
Federal Deposit Insurance Corporation
January 2017
FDIC CFR WP 2017-03
fdic.gov/cfr
NOTE: Staff working papers are preliminary materials circulated to stimulate discussion and critical
comment. The analysis, conclusions, and opinions set forth here are those of the author(s) alone and do not
necessarily reflect the views of the Federal Deposit Insurance Corporation. References in publications to this
paper (other than acknowledgement) should be cleared with the author(s) to protect the tentative character
of these papers.
Lender-Borrower Relationships and
Loan Origination Costs
Philip Ostromogolsky*
Center for Financial Research
Federal Deposit Insurance Corporation
January 2017
Preliminary and incomplete. Please do not cite without permission.
Abstract
Using a recently developed method of causal inference, this paper estimates the addi-
tional up-front loan origination costs that a small business can expect to pay when it
first borrows from a new lender. I compare firms that borrow from a previously unused
financial institution with firms that borrow from a financial institution with which they
have a preexisting financial relationship.† I estimate that firms that borrow from a new
financial institution can expect to pay $5,650 to $6,980 more in closing costs than firms
that return to a previously-used financial in stitution. Based on these findings, I argue
that a central function of origination fees is to pay for the production of detailed, firm-
specific information that is valuable to the lender. I study a natural quasi-experiment
wherein, for a small group of firms, selection into borrowing from a new lender is close to
random. Returning to the wider population of small business borrowers, I use the
method of Altonji, Elder, and Taber (2002, 2005) to account for endogeneity in firms’
selection to borrow from a new lender. The method of Altoji, Elder, and Taber allows
me to measure the degree to which a firm’s selection to borrow from a new lender is
driven by unobservables that also determine closing costs and to correct for any resulting
bias. All analyses confirm that borrowing from a new financial institution causes firms to
pay higher loan origination costs.
* The analysis, opinions, and conclusions presented here are those of the author alone and do not
necessarily reflect the views of the Federal Deposit Insurance Corporation. I am grateful to Matthew
Spiegel for invaluable guidance and support. I thank Rosalind Bennett, Gary Gorton, Levent Guntay,
Vivian Hwa, Emily Johnston-Ross, Stefan Jacewitz, Pavel Kapinos, Stephen Karolyi, Troy Kravitz, Paul
Kupiec, Myron Kwast, Yan Lee, Stefan Lewellen, Steven Malliaris, Andrew Metrick, Oscar Mitnik, Justin
Murfin, Jon Pogach, Carlos Ramirez, Jack Reidhill, Boudhayan Sen, Shyam Sunder, Heather Tookes,
Haluk Unal, and Smith Williams for helpful comments and much-needed suggestions. Author can be
contacted at postromogolsky@fdic.gov.
† A relationship between a firm and a financial institution is said to exist if the firm has previously
conducted business with the financial institution.
Loan Origination Costs
Philip Ostromogolsky*
Center for Financial Research
Federal Deposit Insurance Corporation
January 2017
Preliminary and incomplete. Please do not cite without permission.
Abstract
Using a recently developed method of causal inference, this paper estimates the addi-
tional up-front loan origination costs that a small business can expect to pay when it
first borrows from a new lender. I compare firms that borrow from a previously unused
financial institution with firms that borrow from a financial institution with which they
have a preexisting financial relationship.† I estimate that firms that borrow from a new
financial institution can expect to pay $5,650 to $6,980 more in closing costs than firms
that return to a previously-used financial in stitution. Based on these findings, I argue
that a central function of origination fees is to pay for the production of detailed, firm-
specific information that is valuable to the lender. I study a natural quasi-experiment
wherein, for a small group of firms, selection into borrowing from a new lender is close to
random. Returning to the wider population of small business borrowers, I use the
method of Altonji, Elder, and Taber (2002, 2005) to account for endogeneity in firms’
selection to borrow from a new lender. The method of Altoji, Elder, and Taber allows
me to measure the degree to which a firm’s selection to borrow from a new lender is
driven by unobservables that also determine closing costs and to correct for any resulting
bias. All analyses confirm that borrowing from a new financial institution causes firms to
pay higher loan origination costs.
* The analysis, opinions, and conclusions presented here are those of the author alone and do not
necessarily reflect the views of the Federal Deposit Insurance Corporation. I am grateful to Matthew
Spiegel for invaluable guidance and support. I thank Rosalind Bennett, Gary Gorton, Levent Guntay,
Vivian Hwa, Emily Johnston-Ross, Stefan Jacewitz, Pavel Kapinos, Stephen Karolyi, Troy Kravitz, Paul
Kupiec, Myron Kwast, Yan Lee, Stefan Lewellen, Steven Malliaris, Andrew Metrick, Oscar Mitnik, Justin
Murfin, Jon Pogach, Carlos Ramirez, Jack Reidhill, Boudhayan Sen, Shyam Sunder, Heather Tookes,
Haluk Unal, and Smith Williams for helpful comments and much-needed suggestions. Author can be
contacted at postromogolsky@fdic.gov.
† A relationship between a firm and a financial institution is said to exist if the firm has previously
conducted business with the financial institution.