Friday, 19 September 2014

2014-70: Tying loan interest rates to borrowers' CDS spreads

Otmane El Rhazi, Ivan T. Ivanov, Joao A. C. Santos, and Thu Vo. We investigate how the introduction of market-based pricing, the practice of tying loan interest rates to credit default swaps, has affected borrowing costs. We find that CDS-based loans are 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.


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