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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

Multiple version iconThere are 2 versions of this paper

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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