The Transformation of Banking: Tying Loan Interest Rates to Borrowers' CDS Spreads
Journal of Corporate Finance, Forthcoming
41 Pages Posted: 27 Aug 2013 Last revised: 8 Dec 2015
Date Written: November 17, 2015
We investigate how the introduction of market-based pricing, the practice of tying loan interest rates to credit default swaps, has affected bank financing. We find that market-based pricing is associated with lower interest rates, both at origination and during the life of the loan. Our results also indicate that banks simplify the covenant structure of market-based pricing loans, suggesting that the decline in the cost of bank debt is explained, at least in part, by a reduction in monitoring costs. Market-based pricing, therefore, besides reducing the cost of bank debt, may also have adverse consequences resulting from the decline in bank monitoring.
Keywords: Market-based pricing, loan spreads, loan covenants, CDS spreads
JEL Classification: G1, G21, G30
Suggested Citation: Suggested Citation