Do Banks Compete on Non-Price Terms? Evidence from Loan Covenants

Abstract

We study the interplay between non-price loan terms and competition in credit markets. We
exploit a regulatory supply shock on regulated banks’ ability to offer non-price terms, particularly
covenant-lite loans. We find that borrowers trade-off increased covenants and lower
interest rates from regulated banks, with covenant-lite loans and higher rates from non-bank
lenders. This non-price competition alters market structure, with less covenant-sensitive borrowers
remaining with regulated lenders, and financially weaker borrowers switching to shadow
banks or exiting the market. As a result, banks’ market share declines. Our findings on borrower
behavior and loan terms align with a stylized equilibrium model.

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