Tying Loan Interest Rates to Borrowers' CDS Spreads
56 Pages Posted: 31 May 2017
Date Written: 2014-06-11
We investigate how the introduction of market-based pricing, the practice of tying loan interest rates to credit default swaps, has affected borrowing costs. We find that CDS-based loans are 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: G10, G21, G30
Suggested Citation: Suggested Citation