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The transformation of banking: Tying loan interest rates to borrowers' CDS spreads

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  • Ivanov, Ivan T.
  • Santos, João A.C.
  • Vo, Thu

Abstract

We investigate how the introduction of market-based pricing, the practice of tying loan interest rates to credit default swaps, has affected bank financing. We find that market-based pricing is associated with lower interest rates, both at origination and during the life of the loan. Our results also indicate that banks simplify the covenant structure of market-based pricing loans, suggesting that the decline in the cost of bank debt is explained, at least in part, by a reduction in monitoring costs. Market-based pricing, therefore, besides reducing the cost of bank debt, may also have adverse consequences resulting from the decline in bank monitoring.

Suggested Citation

  • Ivanov, Ivan T. & Santos, João A.C. & Vo, Thu, 2016. "The transformation of banking: Tying loan interest rates to borrowers' CDS spreads," Journal of Corporate Finance, Elsevier, vol. 38(C), pages 150-165.
    • Handle: RePEc:eee:corfin:v:38:y:2016:i:c:p:150-165
    DOI: 10.1016/j.jcorpfin.2016.01.005
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    More about this item

    Keywords

    Market-based pricing; Loan spreads; Loan covenants; CDS spreads;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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