Abstract

http://ssrn.com/abstract=1986956
 
 

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Lender Moral Hazard and Reputation in Originate-to-Distribute Markets


Andrew Winton


University of Minnesota - Twin Cities - Carlson School of Management

Vijay Yerramilli


University of Houston, C. T. Bauer College of Business

November 1, 2011


Abstract:     
We analyze a dynamic model of originate-to-distribute lending in which a bank with significant liquidity needs makes loans and then sells them in the secondary loan market. There is no uncertainty about the bank's monitoring ability or honesty, but the bank may not have incentives to monitor the loan after it has been sold. We examine whether the bank's concern for its reputation, which is based on the number of recent defaults on loans it has originated, can maintain its incentives to monitor. In equilibrium, a bank that has had more recent defaults obtains a lower secondary market price on its current loan and monitors less intensively. Monitoring is more likely to be sustainable if the bank has greater liquidity needs or monitoring has a higher benefit-to-cost ratio; reputation is more valuable for greater liquidity needs, higher monitoring benefit-to-cost ratio, and higher base loan quality. If the bank can commit to retaining part of loans it makes, then a bank with worse reputation retains more of its loan. Competition from a rival lender makes it less likely that monitoring can be sustained and may cause a high-reputation bank to cede the loan to the rival. A temporary increase in loan demand (a "lending boom") makes it less likely that any monitoring can be sustained, especially for low-reputation banks.

Number of Pages in PDF File: 43

Keywords: Monitoring, Reputation, Default

JEL Classification: G21, L14

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Date posted: January 17, 2012 ; Last revised: March 14, 2012

Suggested Citation

Winton, Andrew and Yerramilli, Vijay, Lender Moral Hazard and Reputation in Originate-to-Distribute Markets (November 1, 2011). Available at SSRN: http://ssrn.com/abstract=1986956 or http://dx.doi.org/10.2139/ssrn.1986956

Contact Information

Andrew Winton
University of Minnesota - Twin Cities - Carlson School of Management ( email )
321 19th Avenue South
Department of Finance
Minneapolis, MN 55455
United States
612-624-0589 (Phone)
612-626-1335 (Fax)
Vijay Yerramilli (Contact Author)
University of Houston, C. T. Bauer College of Business ( email )
Houston, TX 77204
United States
713-743-2516 (Phone)
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