Syndication, Interconnectedness, and Systemic Risk

Abstract:     
This paper studies the interconnectedness of banks in the syndicatedloan market as a major source of systemic risk. We develop a set ofnovel measures to describe the "distance" (similarity) betweentwo banks' syndicated loan portfolios and find that such distanceexplains how banks are interconnected in this market. As lead arrangerschoose to work with those that have a similar focus in terms of lendingexpertise, there is a high propensity of bank lenders to concentratesyndicate partners rather than to diversify them. We find some evidenceof potential benefits of this behavior as to lower costs of screeningand monitoring, for example, higher shares of the loan taken by moreconnected lenders and lower loan spreads if syndicated lenders are moreconnected. Lastly, we find that the most heavily interconnected lendersin the syndicated loan market are also the greatest contributors tosystemic risk, suggesting important negative externalities associatedwith the syndication process.

Number of Pages in PDF File: 50

working papers series