The Transformation of Banking: Tying Loan Interest Rates to Borrowers' CDS Spreads

Journal of Corporate Finance, Forthcoming

Simon School Working Paper No. FR 13-25

41 Pages Posted: 27 Aug 2013 Last revised: 8 Dec 2015

Ivan Ivanov

Board of Governors of the Federal Reserve System

João A. C. Santos

Federal Reserve Bank of New York

Thu Vo

Amherst Securities Group LP

Date Written: November 17, 2015

Abstract

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

Ivanov, Ivan and Santos, João A. C. and Vo, Thu, The Transformation of Banking: Tying Loan Interest Rates to Borrowers' CDS Spreads (November 17, 2015). Journal of Corporate Finance, Forthcoming; Simon School Working Paper No. FR 13-25. Available at SSRN: https://ssrn.com/abstract=2316097 or http://dx.doi.org/10.2139/ssrn.2316097

Ivan Ivanov (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

João A. C. Santos

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-5583 (Phone)
212-720-8363 (Fax)

HOME PAGE: HTTP://WWW.NEWYORKFED.ORG/RMAGHOME/ECONOMIST/SANTOS/CONTACT.HTML

Thu Vo

Amherst Securities Group LP ( email )

5001 Plaza on the Lake
Suite 200
Austin, TX 78730
United States

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