Banking on Experience

Abstract

Does bank experience reduce moral hazard in credit markets? Using U.S. corporate loan-level data, we find that, while experience with borrowers and co-lenders reinforces banks’ monitoring incentives, sector experience dilutes them, calling for larger involvement in lending syndicates. In cross-sectional tests, we dissect scenarios in which experience ameliorates lending outcomes. We interpret our findings through a loan syndication model in which experience eases monitoring, but sector experience raises salvage values after loan defaults. To attain identification, we exploit variation in experience at a point in time across firms, sectors, and co-lenders, and use bank mergers as instruments for bank experience.

Keywords: Banks, Experience, Moral Hazard, Sector Specialization, Relationship Lending

JEL Classification: G21, D8