Worth the Risk? The Performance of Banks Reliant on CLO Funding

45 Pages Posted: 6 Apr 2022 Last revised: 7 Apr 2022

See all articles by Santiago Barraza

Santiago Barraza

ESCP Business School

Andrea Civelli

University of Arkansas

Date Written: March 14, 2022

Abstract

We study the effect of bank reliance on CLO funding on bank risk. We document that an exogenous increase in CLO funding significantly decreases bank expected default frequency, with a 1.6% reduction one quarter from the shock for the average bank in response to a standard funding shock. Changes in asset composition and income origination help explain this result. Upon an expansion in CLO funding, banks increase the origination of institutional business loans, fostering origination fees and net noninterest income. Banks also market a large share of the loans they participate in, decreasing the proportion of loans they hold on their balance sheets despite the rise in origination. The performance of the loans they retain on their balance sheets also improves, further strengthening bank conditions. Our results contribute to the literature in bank risk management and the increasing role the shadow banking system plays in funding banks and business lending, carrying relevant implications for the bank regulatory process.

Keywords: CLOs, institutional loans, institutional investors, bank risk, bank performance.

JEL Classification: G21, G23, G32

Suggested Citation

Barraza, Santiago and Civelli, Andrea, Worth the Risk? The Performance of Banks Reliant on CLO Funding (March 14, 2022). Available at SSRN: https://ssrn.com/abstract=4057461 or http://dx.doi.org/10.2139/ssrn.4057461

Santiago Barraza (Contact Author)

ESCP Business School ( email )

79 avenue de la République
75011
France

Andrea Civelli

University of Arkansas ( email )

Fayetteville, AR 72701
United States

HOME PAGE: http://comp.uark.edu/~acivelli/

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