Multi-Bank Loan Pool Contracts
Posted: 6 Aug 2008
Date Written: November 2003
We show that multi-bank loan pools improve the risk-return profile of regional banks' loan business. Banks write simple contracts on the proceeds from pooled loan portfolios, taking into account the agency problems in joint loan production. Thereby, banks benefit from diversifying credit risk while limiting the efficiency loss due to adverse incentives. We present empirical evidence that the formation of loan pools can reduce the volatility in default rates, proxying for credit risk, of participating banks' loan portfolios by roughly 70% in our sample. Under reasonable assumptions, the gain in return on equity (in certainty equivalent terms) is around 20 basis points annually.
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