The Value of Bank Lending

Abstract

Although a vast theoretical literature suggests that banks’ screening and monitoring skill makes them special, there is limited direct evidence on the level and sources of value creation from bank lending activities. Using a novel dataset of realized loan cash-flows and a risk-adjustment methodology adapted from the private equity literature, I provide a loan-level measure of value creation for syndicated loans. I show that banks, on average, earn 190 bps in risk-adjusted returns on each loan they make. Cross-sectionally, value creation is higher when banks lend to financially constrained borrowers and when they retain a higher stake in the deal. In addition to banks earning risk-adjusted income, I show that borrowers are also better off and capture some of the surplus through higher stock market valuations. Overall, my paper documents direct evidence of banks’ critical role in mitigating borrowers’ financing frictions and provides a useful input for policies that encourage prudent lending.

Keywords: Bank Lending, Value Creation, Risk-Adjustment

JEL Classification: G21, G12