The Transformation of Banking: Tying Loan Interest Rates to Borrowers' CDS Spreads

Journal of Corporate Finance 38, 150-165, 2016.

Simon School Working Paper No. FR 13-25

41 Pages Posted: 27 Aug 2013 Last revised: 1 Mar 2021

See all articles by Ivan Ivanov

Ivan Ivanov

Federal Reserve Bank of Chicago

João A. C. Santos

Federal Reserve Bank of New York; Nova School of Business and Economics

Thu Vo

Amherst Securities Group LP

Multiple version iconThere are 2 versions of this paper

Date Written: November 17, 2015

Abstract

We investigate how the introduction of market-based pricing, the practice of tying loan interest rates to credit default swaps, has affected bank financing. We find that market-based pricing is associated with lower interest rates, both at origination and during the life of the loan. Our results also indicate that banks simplify the covenant structure of market-based pricing loans, suggesting that the decline in the cost of bank debt is explained, at least in part, by a reduction in monitoring costs. Market-based pricing, therefore, besides reducing the cost of bank debt, may also have adverse consequences resulting from the decline in bank monitoring.

Keywords: Market-based pricing, loan spreads, loan covenants, CDS spreads

JEL Classification: G1, G21, G30

Suggested Citation

Ivanov, Ivan and Santos, João A. C. and Vo, Thu, The Transformation of Banking: Tying Loan Interest Rates to Borrowers' CDS Spreads (November 17, 2015). Journal of Corporate Finance 38, 150-165, 2016., Simon School Working Paper No. FR 13-25, Available at SSRN: https://ssrn.com/abstract=2316097 or http://dx.doi.org/10.2139/ssrn.2316097

Ivan Ivanov (Contact Author)

Federal Reserve Bank of Chicago ( email )

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João A. C. Santos

Federal Reserve Bank of New York ( email )

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Thu Vo

Amherst Securities Group LP ( email )

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Suite 200
Austin, TX 78730
United States

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