Credit derivatives and loan pricing

This paper examines the relation between the new markets for credit default swaps (CDS) and banks’ pricing of syndicated loans to US corporates. We find that changes in CDS spreads have a significantly positive coefficient and explain about 25% of subsequent monthly changes in aggregate loan spreads during 2000–2005. Moreover, when compared to traditional explanatory factors, they turn out to be the dominant determinant of loan spreads. In particular, they explain loan rates much better than same rated bonds. This suggests that CDS prices contain, beyond general credit risk, to a substantial extent information relevant for bank lending. We also find that, over time, new information from CDS markets is faster incorporated into loans, but information from other markets is not. Overall, our results indicate that the markets for CDS have gained an important role for banks.     

Bank lending opportunities and credit standards

This article empirically tests the hypothesis that credit-screening standards can be first increasing and then decreasing in the quality of the bank's pool of potential borrowers, which in turn may vary through the business cycle or across different segments of the lending markets. A key implication is that banks with lending opportunities toward the middle of the quality spectrum can have loan portfolios that perform better than do the portfolios of banks with loan-origination opportunities that are either too weak or too strong. Using banks’ volume of secondary-market loan sales as a proxy for the richness of lending opportunities, I find an inverse U-shaped relation between the performance of banks’ loan portfolios and their activity in the loan sales market. The pattern deserves scrutiny for its policy implications, as many regulators hold the view that countercyclical variation in credit standards may have a destabilizing effect on business cycles.     

Optimal credit risk transfer, monitored finance, and banks

We examine the implications of optimal credit risk transfer (CRT) for bank-loan monitoring, and the incentives for banks to engage in optimal CRT. In our model, properly designed CRT instruments allow banks to insure themselves against loan losses precisely in those states that signal monitoring. We find that optimal CRT enhances loan monitoring and expands financial intermediation, in contrast to the findings of the previous literature. Optimal CRT instruments are based on loan portfolios rather than individual loans and have credit-enhancement guarantees, pretty much as banks do in practice. But the extent of credit enhancement needs to be precisely delimited. Above that exact level, monitoring incentives are undermined (loan quality deteriorates) and wealth is transferred from the bank's financiers to the bank. Properly designed risk-based capital requirements are shown to prevent such a wealth transfer and to provide banks with the incentive to engage in optimal CRT.     

Moral Hazard and Optimal Subsidiary Structure for Financial Institutions

Banks and related financial institutions often have two separate subsidiaries that make loans of similar type but differing risk, for example, a bank and a finance company, or a “good bank/bad bank” structure. Such “bipartite” structures may prevent risk shifting, in which banks misuse their flexibility in choosing and monitoring loans to exploit their debt holders. By “insulating” safer loans from riskier loans, a bipartite structure reduces risk‐shifting incentives in the safer subsidiary. Bipartite structures are more likely to dominate unitary structures as the downside from riskier loans is higher or as expected profits from the efficient loan mix are lower.     

Bank loans and bond prices

We test whether bank loans change public bond yields. A 25% increase in bank debt raises bond yields by 8 bps, reflecting a trade-off between the benefits of bank cross-monitoring and higher bond risk. This effect is smaller for firms with no credit default swaps (CDSs) and with junk debt—scenarios where bank monitoring is most valuable. It is unlikely that firms with bank debt are riskier, because they are less likely to be downgraded and have lower loan spreads. We find similar results using a natural experiment around the 2014 oil shock. Our results highlight how bond yields depend on incentive conflicts among creditors.     

What influences banks’ choice of credit risk management practices? Theory and evidence

Banks use different risk management practices with varying levels of sophistication. This paper examines the factors that determine the choice of risk-management practices. In a theoretical model, we identify two main determinants for the choice of risk management tools: bank competition and sector concentration in the loan market. We empirically test the predictions of our model using hand-collected data on the credit risk management of 249 German savings banks. The results are in line with our theory: Competition pushes banks to implement advanced risk management practices. Sector concentration in the loan market promotes credit portfolio modeling, but it inhibits credit risk transfer.     

The role of managerial risk‐taking in the ‘rise and fall’ of the CDS market

Since the innovation of credit default swaps (CDSs) in 1997, the market for CDSs grew dramatically to $62 trillion in 2007 (ISDA 2010). However, this market declined significantly with the onset of the GFC, prompting the question, ‘What lies behind the phenomenal growth and the eventual collapse of the CDS market?’ Using CDS spread data from 319 bank and non‐bank financial institutions across 33 countries over the period 2001–2010, I provide evidence of the determinants that affect risk‐taking by financial institutions, proxied by CDS spreads, and argue within an agency theoretical framework that managerial risk‐taking contributed to the ‘rise and fall’ of the CDS market.     

Loan collateral,corporate investment,and business cycle

Collateral and loan rates are observed to be highly cyclical in their use for bank lending. The effects of such cyclicality on corporate investment are analyzed in this paper using a dynamic model. We find that more collateral causes firms to select riskier (/safer) projects if the loan rate rises above (/falls below) the expected investment return. We show that the incentive effect of loan rates becomes stronger with greater collateral, with the two credit terms having larger incentive effects on lower-quality firms. These results offer a new explanation for why lenient collateral policies are associated with rising loan rates in economic upturns but stricter collateral requirements come with falling loan rates during downturns.     

浅析农户个人信贷业务拓展中的障碍和对策建议

中国经济长期以来呈现出“重城轻乡”的二元制结构特点,在这种经济结构背景下的城乡个人信贷政策却没有实行差别化,这是造成我国农村个人信贷业务难以推进的主要障碍。目前银行在针对个人办理贷款时都有一些硬性条件,包括面临风险时贷款利率会适当上浮,个人贷款期限以年为单位,要求借款人一定时间内支出与收入比不得超过50％,这些政策和限制性条件对农户贷款并不适用,在为农户办理贷款时应适用新的信贷政策,使其更贴近农户的实际信贷需求。     

Credit derivatives and bank credit supply

Credit derivatives are the latest in a series of innovations that have had a significant impact on credit markets. Using a micro data set of individual corporate loans, this paper explores whether use of credit derivatives is associated with an increase in bank credit supply. We find only limited evidence that greater use of credit derivatives is associated with greater supply of bank credit. The strongest effect is for large term loans—newly negotiated loan extensions to large corporate borrowers, with a largely negative impact on (previously negotiated) commitment lending. Even for large term borrowers, increases in the volume of credit are offset by higher spreads. These findings suggest that the benefits of the growth of credit derivatives may be narrow, accruing mainly to large firms that are likely to be “named credits” in these transactions. Finally, use of credit derivatives appears to be complementary to other forms of hedging by banks, though the banks most active in hedging appear to charge more for additional amounts of credit.     

The real effects of credit default swaps

We examine the effect of introducing credit default swaps (CDSs) on firm value. Our model allows for dynamic investment and financing, and bondholders can trade in the CDS market. The model incorporates both negative and positive effects of CDSs. CDS markets lead to more liquidations, but they also reduce the probability of costly debt renegotiation and reduce costly equity financing. After calibrating the model, we find that firm value increases by 2.9% on average with the introduction of a CDS market. Firms also invest more and increase leverage. The effect on firm value is strongest for small, financially constrained, and low productivity firms.     

Good and bad credit contagion: Evidence from credit default swaps

This study examines the intra-industry information transfer effect of credit events, as captured in the credit default swaps (CDS) and stock markets. Positive correlations across CDS spreads imply that contagion effects dominate, whereas negative correlations indicate competition effects. We find strong evidence of contagion effects for Chapter 11 bankruptcies and competition effects for Chapter 7 bankruptcies. We also introduce a purely unanticipated event, in the form of a large jump in a company's CDS spread, and find that this leads to the strongest evidence of credit contagion across the industry. These results have important implications for the construction of portfolios with credit-sensitive instruments.     

Monetary policy and bank risk-taking: Evidence from the corporate loan market

Our study of the corporate loan pricing policies of U.S. banks over the past two decades shows that loan spreads for riskier firms become relatively lower during periods of monetary policy easing compared to tightening. This effect is driven by banks with greater risk appetite, measured from individual banks’ answers to the Senior Loan Officers Opinion Survey. Our results hold with different fixed effects that account for time-varying observed and unobserved heterogeneity of credit demand and bank lending conditions that are not directly related to monetary policy. Together with our survey-based measure of bank risk appetite, we provide compelling evidence of the presence of a bank risk-taking channel of monetary policy in the U.S.     

Deposit insurance and credit union lending

We exploit an exogenous change in the coverage of insured deposits following the passage of the Emergency Economic Stabilization Act (2008) to investigate the impact of deposit insurance on the volume, composition and quality of credit union lending. Using a difference-in-difference approach, we find changes in the volume, composition and riskiness of credit union lending. Specifically, we find that affected credit unions increase total and unsecured lending, leading to a decline in loan quality. Overall, our results suggest that an increase in the maximum coverage of insured deposits induces credit unions to lend more at the expense of loan quality.     

Finance and inequality: The distributional impacts of bank credit rationing

We analyze reductions in bank credit using a natural experiment where unprecedented flooding in Pakistan differentially affected banks that were more exposed to the floods. Using a unique data set that covers the universe of consumer loans in Pakistan and this exogenous shock to bank funding, we find two key results. First, following an increase in their funding costs, banks disproportionately reduce credit to borrowers with little education, little credit history, and seasonal occupations. Second, the credit reduction is not compensated by relatively more lending by less-affected banks. The empirical evidence suggests that a reduction in bank monitoring incentives caused the large relative decreases in lending to these borrowers.     

Banking deregulation and credit risk: Evidence from the EU

This paper studies the effect of banking deregulation on credit risk. Its theoretical model shows that a bank is willing to invest more resources in screening borrowers when there is an entry threat, even though loan rates are driven lower. Thus, deregulation may result in improved loan quality and lower credit risk. This result is tested using bank-level balance sheet data and macroeconomic data for the European Union. The data reveal that competition intensified after the completion of the Second Banking Directive, while loan quality improved in most markets. Evidence is found that the loan quality improvement is associated with lower interest margin.     

Asymmetric information effects on loan spreads

This paper estimates the cost arising from information asymmetry between the lead bank and members of the lending syndicate. In a lending syndicate, the lead bank retains only a fraction of the loan but acts as the intermediary between the borrower and the syndicate participants. Theory predicts that asymmetric information will cause participants to demand a higher interest rate and that a large loan ownership by the lead bank should reduce this effect. In equilibrium, however, the asymmetric information premium demanded by participants is offset by the diversification premium demanded by the lead. Using shifts in the idiosyncratic credit risk of the lead bank's loan portfolio as an instrument, I measure the asymmetric information effect of the lead's share on the loan spread and find that it accounts for approximately 4% of the total cost of credit.     

Bank-firm relationship and credit risk: An analysis on Tunisian firms

This paper analyses the impact of the intensity and length of bank-firm lending relationship on Tunisian banks’ credit risk over the period 2001–2012. The sample includes 494 bank-firm relationships for 383 firms. By applying probit and ordered probit models, our results indicate that firms which engage in intense relationships with banks are less likely to encounter a credit default. In addition, these firms exhibit a higher loan quality. However, no evidence has been found for the impact of the relationship length on credit risk. Further, the findings show that private banks, unlike public financial institutions, take advantage of their close lending relationships with borrowers to mitigate information asymmetry and therefore improve their loans portfolio quality.     

Credit Default Swaps and Managers’ Voluntary Disclosure

We investigate how the availability of traded credit default swaps (CDSs) affects the referenced firms’ voluntary disclosure choices. CDSs enable lenders to hedge their credit risk exposure, weakening their incentives to monitor borrowers. We predict that reduced lender monitoring in turn leads shareholders to intensify their monitoring and demand increased voluntary disclosure from managers. Consistent with this expectation, we find that managers are more likely to issue earnings forecasts and forecast more frequently when traded CDSs reference their firms. We further find a stronger impact of CDS availability on firm disclosure when (1) lenders have higher ability and propensity to hedge credit risk using CDSs, and (2) lender monitoring incentives and monitoring strength are weaker. Consistent with an increase in shareholder demand for public information disclosure induced by a reduction in lender monitoring, we find a stronger effect of CDSs on voluntary disclosure for firms with higher institutional ownership and stronger corporate governance. Overall, our findings suggest that firms with traded CDS contracts enhance their voluntary disclosure to offset the effect of reduced monitoring by CDS‐protected lenders.     

The behavior of consumer loan rates during the 1990 credit slowdown

This study re-examines the 1990 credit slowdown by investigating the loan pricing behavior of commercial banks. We find strong evidence that large, undercapitalized banks contributed to the credit slowdown by charging consumers a higher-than-average loan rate relative to better-capitalized institutions. This disparity in lending exists even after accounting for bank funding costs. Thus, we argue that there was a lending slowdown that occurred among large, undercapitalized banks. The reluctance to lend among undercapitalized banks is at least suggestive of behavior that is consistent with a credit crunch.