Does Bank Monitoring Influence Loan Contract Terms?

We examine the impact of bank monitoring on loan contract terms using a new proxy for monitoring ability based on the labor input into monitoring. We show in out-of-sample tests that the proxy is a statistically and economically significant determinant of future loan quality. Accounting for clustering of observations by lead bank, and controlling for borrower characteristics, contract features and bank risk, we find a statistically significant direct relationship between monitoring ability and loan maturity and a statistically and economically significant direct relationship between monitoring ability and the loan yield spread. The relationships are particularly strong for working capital loans. The views and opinions expressed in this paper are those of the authors and do not necessarily reflect those of the Australian Prudential Regulation Authority.