The Fixed or Variable Rate Loan Decision: Which Small Businesses Prefer the Certainty of Fixed Rate Loans and Which Banks Offer Them?

Abstract

If a small business expects that interest rates will rise in the future then it is rational to insure oneself against this by accepting a fixed rate loan. In addition, small firms may prefer the certainty of fixed interest payments throughout the term of a loan. However, banks may prefer to offer variable rate loans as this insures them against volatility and uncertainty of their funding cost and shifts risk to the borrower. In this paper we empirically analyse what types of lending institutions offer fixed rate loans and what types of small firms accept them using a large UK data set from 2009–2020 covering government guaranteed loans. We initially found that fixed rate loans are more expensive than variable rate loans on average, and that larger firms and those taking out longer maturity loans were more likely to take out fixed rate loans. In contrast, larger size loans were more likely to be issued on a variable interest rate and by a larger lending institution. As large banks made greater returns from fixed rate loans, they increased use of them over the decade to favoured borrowers suggesting that regret aversion also played a role in the bank's decision and also that macroeconomic conditions were improving after the Global Financial Crisis.