Bank Loans, Bonds, and Information Monopolies Across the Business Cycle
João A. C. Santos
Federal Reserve Bank of New York
University of Minnesota - Twin Cities - Carlson School of Management
December 21, 2006
AFA 2006 Boston Meetings Paper
Theory suggests that banks' private information about borrowers lets them hold up borrowers for higher interest rates. Since hold-up power increases with borrower risk, banks with exploitable information should be able to raise their rates in recessions by more than is justified by borrower risk alone. We test this hypothesis by comparing the pricing of loans for bank-dependent borrowers with the pricing of loans for borrowers with access to public debt markets, controlling for loan- and firm-specific risk factors. Loan spreads rise in recessions, but firms with public debt market access pay lower spreads and their spreads rise significantly less in recessions. Our findings suggest that, during recessions, banks do in fact charge higher rates to customers with limited outside funding options, and that the magnitude of this effect is economically significant.
Number of Pages in PDF File: 57
Keywords: bank loans, bonds, information rents, hold-up problem
JEL Classification: G21, G32
Date posted: March 26, 2005
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