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We use a matched sample of individual loans, borrowers, and banks to investigate the effect of banks' financial health on the cost of loans, controlling for borrower risk and information costs. Our principal finding is that low‐capital banks tend to charge higher loan rates than well‐capitalized banks. This effect is primarily associated with firms for which information costs are likely to be important, and, when borrowing from weak banks, these firms tend to hold more cash. The results indicate that many firms face significant costs in switching lenders and thus provide support for the bank lending channel of monetary transmission.