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Financial Innovation and Bank Behavior: Evidence from Credit Markets

36 Pages Posted: 6 Apr 2011 Last revised: 24 Aug 2012

Lars Norden

Brazilian School of Public and Business Administration (EBAPE), Getulio Vargas Foundation (FGV)

Consuelo Silva Buston

Universidad de los Andes

Wolf Wagner

Erasmus University Rotterdam (EUR) - Rotterdam School of Management (RSM); Centre for Economic Policy Research (CEPR)

Date Written: December 23, 2011

Abstract

This paper investigates whether, and through which channel, the active use of credit derivatives changes bank behavior in the credit market, and how this channel was affected by the crisis of 2007-2009. Our principal finding is that banks with larger gross positions in credit derivatives charge significantly lower corporate loan spreads, while banks' net positions are not related to loan pricing. We argue that this is consistent with banks passing on risk management benefits to corporate borrowers but not with alternative channels through which credit derivative use may affect loan pricing. We also find that the magnitude of the risk management effect remained unchanged during the crisis period of 2007-2009. In addition, banks with larger gross positions in credit derivatives cut their lending by less than other banks during the crisis and have consistently lower loan charge-offs. In sum, our study is suggestive of significant risk management benefits from financial innovations that persist under adverse conditions -- that is, when they matter most.

Keywords: Financial innovations, credit derivatives, syndicated loans, loan pricing, financial crisis

JEL Classification: G21, G32, G01

Suggested Citation

Norden, Lars and Silva Buston, Consuelo and Wagner, Wolf, Financial Innovation and Bank Behavior: Evidence from Credit Markets (December 23, 2011). Available at SSRN: https://ssrn.com/abstract=1800162 or http://dx.doi.org/10.2139/ssrn.1800162

Lars Norden

Brazilian School of Public and Business Administration (EBAPE), Getulio Vargas Foundation (FGV) ( email )

Praia de Botafogo, 190
Rio de Janeiro, 22250-900
Brazil
+552137995759 (Phone)

Consuelo Silva Buston

Universidad de los Andes ( email )

Monsenor Alvaro del Portillo 12455
santiago, ZZ 99999
Chile
226181834 (Phone)
226181834 (Fax)

Wolf Wagner (Contact Author)

Erasmus University Rotterdam (EUR) - Rotterdam School of Management (RSM) ( email )

P.O. Box 1738
Room T08-21
3000 DR Rotterdam, 3000 DR
Netherlands

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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