Benign Neglect of Covenant Violations: Blissful Banking or Ignorant Monitoring?

55 Pages Posted: 22 Jan 2019

See all articles by Stefano Colonnello

Stefano Colonnello

Ca Foscari University of Venice; Halle Institute for Economic Research

Michael Koetter

Halle Institute for Economic Research

Moritz Stieglitz

Deutsche Bundesbank; Halle Institute for Economic Research

Date Written: January 19, 2019

Abstract

Theoretically, bank's loan monitoring activity hinges critically on its capitalization. To proxy for monitoring intensity, we use changes in borrowers' investment following loan covenant violations, when creditors can intervene in the governance of the fi rm. Exploiting granular bank-fi rm relationships observed in the syndicated loan market, we document substantial heterogeneity in monitoring across banks and through time. Better capitalized banks are more lenient monitors that intervene less with covenant violators. Importantly, this hands-off approach is associated with improved borrowers' performance. Beyond enhancing financial resilience, regulation that requires banks to hold more capital may thus also mitigate the tightening of credit terms when firms experience shocks.

Keywords: Bank Monitoring, Covenant Violations, Syndicated Loans, Business Cycle

JEL Classification: G21, G32, G33, G34

Suggested Citation

Colonnello, Stefano and Koetter, Michael and Stieglitz, Moritz, Benign Neglect of Covenant Violations: Blissful Banking or Ignorant Monitoring? (January 19, 2019). Available at SSRN: https://ssrn.com/abstract=3318973 or http://dx.doi.org/10.2139/ssrn.3318973

Stefano Colonnello (Contact Author)

Ca Foscari University of Venice ( email )

Dorsoduro 3246
Venice, Veneto 30123
Italy

Halle Institute for Economic Research ( email )

P.O. Box 11 03 61
Kleine Maerkerstrasse 8
D-06017 Halle, 06108
Germany

Michael Koetter

Halle Institute for Economic Research ( email )

P.O. Box 11 03 61
Kleine Maerkerstrasse 8
D-06017 Halle, 06108
Germany

HOME PAGE: http://www.iwh-halle.de/en/about-the-iwh/people/detail/michael-koetter/

Moritz Stieglitz

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Halle Institute for Economic Research ( email )

P.O. Box 11 03 61
Kleine Maerkerstrasse 8
D-06017 Halle, 06108
Germany

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