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Self-Selection and the Pricing of Bank Services: an Analysis of the Market for Loan Commitments and the Role of Compensating Balance Requirements

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  • James, Christopher

Abstract

The idea that various characteristics of financial contracts and institutions can be explained as a rational response to problems created by information asymmetries has received a great deal of attention recently. A central theme of the literature in this area is that while moral hazard may hamper the direct transfer of information between market participants, information may be conveyed indirectly through the actions of market participants. For example, the characteristics of the insurance contract purchased may convey information as to riskiness of the insured. Recognition of the possible effects of information asymmetries has provided valuable insights into the role of financial intermediaries and the characteristics of the contracts they offer. In this paper we apply this literature to an analysis of the market for bank loan commitments. Through our analysis we are able to explain the use of various payment options such as fees and compensating balance requirements associated with loan commitments. Extensions of our analysis into the pricing of other bank services are also explored.

Suggested Citation

  • James, Christopher, 1981. "Self-Selection and the Pricing of Bank Services: an Analysis of the Market for Loan Commitments and the Role of Compensating Balance Requirements," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 16(5), pages 725-746, December.
    • Handle: RePEc:cup:jfinqa:v:16:y:1981:i:05:p:725-746_00
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    Citations

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    Cited by:

    1. Thakor, Anjan V. & Udell, Gregory F., 1987. "An economic rationale for the pricing structure of bank loan commitments," Journal of Banking & Finance, Elsevier, vol. 11(2), pages 271-289, June.
    2. Laidroo, Laivi & Männasoo, Kadri, 2017. "Do credit commitments compromise credit quality?," Research in International Business and Finance, Elsevier, vol. 41(C), pages 303-317.
    3. Boot, Arnoud & Thakor, Anjan V. & Udell, Gregory F., 1987. "Competition, risk neutrality and loan commitments," Journal of Banking & Finance, Elsevier, vol. 11(3), pages 449-471, September.
    4. Zhao, Yijia (Eddie), 2021. "Does credit type matter for relationship lending? The special role of bank credit lines," Finance Research Letters, Elsevier, vol. 38(C).
    5. Vitaly M. Bord & João A.C. Santos, 2014. "Banks' Liquidity and the Cost of Liquidity to Corporations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 46(s1), pages 13-45, February.
    6. Bouwman, Christa H. S., 2013. "Liquidity: How Banks Create It and How It Should Be Regulated," Working Papers 13-32, University of Pennsylvania, Wharton School, Weiss Center.
    7. Stanhouse, Bryan & Schwarzkopf, Al & Ingram, Matt, 2011. "A computational approach to pricing a bank credit line," Journal of Banking & Finance, Elsevier, vol. 35(6), pages 1341-1351, June.
    8. Chateau, J. -P. & Dufresne, D., 2002. "The stochastic-volatility American put option of banks' credit line commitments:: Valuation and policy implications," International Review of Financial Analysis, Elsevier, vol. 11(2), pages 159-181.

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