In theory it can be proved that the risk premium charged by banks increases with the debt-to-asset ratio and maturity of loans( Freixas and Rochet, 2008). In practice, many banks employ various models to measure credit risks. Those models generally have multiple indicators outlining various aspects of the risk related to borrowing firms The most commonly used indicators include total asset, total employment, liquid asset ratio, debt-to-asset ratio, profit margin and equity-to-debt ratio etc. In addition, some qualitative indicators are also included: The sector of the firm, the area where the firm is located, the ownership of the firm etc(Mu, 2007). Of course, the riskiness of loans is affected by the existence of collateral, which will be considered in loan pricing On the other hand various contract features are also used to mitigate credit risk in bank lending practice to enhance their ability to monitor borrowers over the course of the relationship(Strahan, 1999). Loan size is one of these features, which limits the banks potential exposure to credit risk of a specific borrower. Other features such as maturity and collateral of loans also play important roles in reducing credit risk in lending practice d ). Bank efficiency and price sensitivity of loans According to Equations(4)and (5), both loan rate and loan amount are also affected by efficiency of bank lending, which can be largely measured by managing costs of banks such as screening, monitoring and branching costs etc. dr N(AD-2r) >0 since ad-2r>0 and. >r d6(N+824)2 dL -N2(AD-1rnr) o8(N+84) <0 since AD-n, >0, and n,>0 (7) From Equation(6)and(7)it is easy to see that loan pricing is positively correlated to banks' managing costs and the opposite applies to loan amount. However, in the empirical analysis it is hard to get detailed data about managing cost of screening and monitoring since this data is usually commercially confidential. The way we deal with this issue is to include dummies variables for banks so as to control for divergent efficiency across them. Another factor impacting loan pricing is price sensitivity of loans, which is clearl negatively related to loan rate from Equation(4). Intuitively it makes perfect sense that banks could charge a firm with higher prices when loan demands from firms are insensitive to loan rates. In the empirical study we assume the price sensitivity of loans can in general be captured by a firm' s characteristics and dummies representing firm's industries 4.2 What determines loan rate and loan size? comprehensive discussion about this can be found at Chapter 8 in Freixas and Rochet (2008). ompanies like Standard Poor's, Moody's Analytics, Fitch Ratings, and Dun and Bradstreet provide such services. Most Chinese commercial banks have adopted quantitative credit risk evaluation models, for example, ICBC use s rating system similar to Standard Poors to evaluate credit risk from borrowers(Mu10 In theory it can be proved that the risk premium charged by banks increases with the quasi debt-to-asset ratio and maturity of loans (Freixas and Rochet, 2008). In practice, many banks employ various models to measure credit risks.7 Those models generally have multiple indicators outlining various aspects of the risk related to borrowing firms. The most commonly used indicators include total asset, total employment, liquid asset ratio, debt-to-asset ratio, profit margin and equity-to-debt ratio etc. In addition, some qualitative indicators are also included: The sector of the firm, the area where the firm is located, the ownership of the firm etc (Mu, 2007). Of course, the riskiness of loans is affected by the existence of collateral, which will be considered in loan pricing. On the other hand, various contract features are also used to mitigate credit risk in bank lending practice to enhance their ability to monitor borrowers over the course of the relationship (Strahan, 1999). Loan size is one of these features, which limits the bank’s potential exposure to credit risk of a specific borrower. Other features such as maturity and collateral of loans also play important roles in reducing credit risk in lending practice. d). Bank efficiency and price sensitivity of loans According to Equations (4) and (5), both loan rate and loan amount are also affected by efficiency of bank lending, which can be largely measured by managing costs of banks such as screening, monitoring and branching costs etc. 2 ( ) ( ) L l l nr L l N r N AD r δ λ λ δ + − = ∂ ∂ >0 since l l AD − λ r >0 and l nr r > r (6) 0 ( ) ( ) 2 < + − − = ∂ ∂ L l l l nr L N L N AD r δ λ λ λ δ since l l AD − λ r >0, and λl >0 (7) From Equation (6) and (7) it is easy to see that loan pricing is positively correlated to banks’ managing costs and the opposite applies to loan amount. However, in the empirical analysis it is hard to get detailed data about managing cost of screening and monitoring since this data is usually commercially confidential. The way we deal with this issue is to include dummies variables for banks so as to control for divergent efficiency across them. Another factor impacting loan pricing is price sensitivity of loans, which is clearly negatively related to loan rate from Equation (4). Intuitively it makes perfect sense that banks could charge a firm with higher prices when loan demands from firms are insensitive to loan rates. In the empirical study we assume the price sensitivity of loans can in general be captured by a firm’s characteristics and dummies representing firm’s industries. 4.2 What determines loan rate and loan size? comprehensive discussion about this can be found at Chapter 8 in Freixas and Rochet (2008). 7 Companies like Standard & Poor's, Moody's Analytics, Fitch Ratings, and Dun and Bradstreet provide such services. Most Chinese commercial banks have adopted quantitative credit risk evaluation models, for example, ICBC use s rating system similar to Standard & Poor's to evaluate credit risk from borrowers (Mu, 2007)