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 specific forms of experience ameliorate lending outcomes. We interpret our findings through a loan syndication model in which all forms of experience ease monitoring, but sector experience raises asset liquidation values after loan defaults, diluting lenders’ incentives to monitor. 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 the different forms of bank experience.

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