Moral Hazard and Adverse Selection in the Originate-to-Distribute Model of Bank Credit

36 Pages Posted: 28 Oct 2008 Last revised: 9 Aug 2014

Antje Berndt

Australian National University

Anurag Gupta

Case Western Reserve University - Department of Banking & Finance

Date Written: February 25, 2009

Abstract

Bank credit has evolved from the traditional relationship banking model to an originate-to-distribute model. We show that the borrowers whose loans are sold in the secondary market underperform their peers by about 9% per year (risk-adjusted) over the three-year period following the initial sale of their loans. Therefore, either banks are originating and selling loans of lower quality borrowers based on unobservable private information (adverse selection), and/or loan sales lead to diminished bank monitoring that affects borrowers negatively (moral hazard). We propose regulatory restrictions on loan sales, increased disclosure, and a loan trading exchange/clearinghouse as mechanisms to alleviate these problems.

Keywords: Syndicated loans, Loan secondary market, Bank credit, Moral hazard, Adverse selection

JEL Classification: G12, G18, G21, G32

Suggested Citation

Berndt, Antje and Gupta, Anurag, Moral Hazard and Adverse Selection in the Originate-to-Distribute Model of Bank Credit (February 25, 2009). Available at SSRN: https://ssrn.com/abstract=1290312 or http://dx.doi.org/10.2139/ssrn.1290312

Antje Berndt

Australian National University ( email )

Kingsley st.
acton, ACT 0200
Australia

Anurag Gupta (Contact Author)

Case Western Reserve University - Department of Banking & Finance ( email )

10900 Euclid Ave.
Cleveland, OH 44106-7235
United States
216-368-2938 (Phone)
216-368-4776 (Fax)

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