Is the Secondary Loan Market Valuable for Borrowers?
31 Pages Posted: 5 Nov 2007
Date Written: November 1, 2007
In recent years, the secondary loan market has developed into an over-the-counter market where loans are sold and subsequently traded. This shift away from traditional banking is altering the business of lending for both banks and their borrowers. Loan sales are valuable to banks because they free up capital and facilitate risk management; but they may be costly to borrowers because they negatively affect bank monitoring incentives. In this paper, however, we argue that there is another potential benefit to borrowers from loan sales. Borrowers with trading loans, in particular those with liquid loans, may "demand" a share of bank benefits from loan sales when they take out new loans as it will be easier for banks to sell these loans afterwards. We investigate this potential benefit of the secondary loan market by comparing the interest rates borrowers pay before their loans start to trade with the interest rates they pay on loans originated post-trading. Our results show that, on average, borrowers pay higher spreads on the loans they take out after the onset of trading on their loans. Importantly, our results also show that borrowers with liquid trading loans are able to borrow at lower interest rates after the onset of trading on their loans. This interest rate discount is robust and economically meaningful. Thus, while the banks' decision to sell loans may initially impose a cost on borrowers, those whose loans enter the secondary loan market and become liquid benefit from an interest rate discount on their subsequent loans.
Keywords: loan spreads, bid-ask spreads, liquidity, secondary loan market
JEL Classification: G21, G34
Suggested Citation: Suggested Citation