Abstract

http://ssrn.com/abstract=2316097
 
 

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


Ivan Ivanov


U.S. Securities and Exchange Commission

João A. C. Santos


Federal Reserve Bank of New York

Thu Vo


University of Rochester - Simon Business School

August 26, 2013

Simon School Working Paper No. FR 13-25

Abstract:     
We investigate how the introduction of market-based pricing -- the practice of tying loan interest rate spreads to credit default swaps -- has affected the cost of bank debt. Our results indicate that market-based pricing has reduced the cost of bank loans. Borrowers with CDS-based loans have benefited from a decline in interest rate spreads both at the time of loan origination and during the life of the loan. We find that banks simplify the covenant structure of market-based pricing loans and that market-based pricing lines of credit are associated with lower fees than standard revolvers. These findings suggest that the decline in the cost of bank debt is explained, at least in part, by a reduction in monitoring costs. Overall, market-based pricing might lead to a reduction in the cost of bank debt, but it may also have some adverse effects resulting from its negative impact on banks' monitoring efforts.

Number of Pages in PDF File: 49

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

JEL Classification: G21, G30

Accepted Paper Series


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Date posted: August 27, 2013  

Suggested Citation

Ivanov, Ivan and Santos, João A. C. and Vo, Thu, The Transformation of Banking: Tying Loan Interest Rates to Borrowers' CDS Spreads (August 26, 2013). Simon School Working Paper No. FR 13-25. Available at SSRN: http://ssrn.com/abstract=2316097 or http://dx.doi.org/10.2139/ssrn.2316097

Contact Information

Ivan Ivanov (Contact Author)
U.S. Securities and Exchange Commission ( email )
100 F Street, NE
Washington, DC 20549
United States
João A. C. Santos
Federal Reserve Bank of New York ( email )
33 Liberty Street
New York, NY 10045
United States
212-720-5583 (Phone)
212-720-8363 (Fax)
HOME PAGE: HTTP://WWW.NEWYORKFED.ORG/RMAGHOME/ECONOMIST/SANTOS/CONTACT.HTML
Thu Vo
University of Rochester - Simon Business School ( email )
Rochester, NY 14627
United States
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