Do Banks Compete on Non-Price Terms? The Dollar Value of Loan Covenants

Abstract

We investigate the tradeoff between control rights tied to loan covenants and cash flow rights from interest rates. We exploit a regulatory shock that restricted banks, but not non-banks, from offering covenant-lite loans. In response, affected banks increased covenant provisions while reducing interest rates relative to non-banks. We estimate a "dollar value of covenants" around 2.5%, or $15mln annually for the average loan. This value rises with borrowers' demand for flexibility and falls with lenders' ability to monitor covenants. Stricter non-price terms drive financially weaker borrowers toward shadow banks or out of the leveraged lending market, reducing banks' market share.

Keywords: non-price competition, shadow banks, leveraged lending, covenants, syndicated loans, relationship lending