This paper studies the interconnectedness of banks in the syndicated loan market as a major source of systemic risk. We develop a set of novel measures to describe the "distance" (similarity) between two banks'syndicated loan portfolios and …nd that such distance explains how banks are interconnected in this market. As lead arrangers choose to work with those that have a similar focus in terms of lending expertise, there is a high propensity of bank lenders to concentrate syndicate partners rather than to diversify them. We …nd some evidence of potential bene…ts of this behavior as to lower costs of screening and monitoring, for example, higher shares of the loan taken by more connected lenders and lower loan spreads if syndicated lenders are more connected.Lastly, we …nd that the most heavily interconnected lenders in the syndicated loan market are also the greatest contributors to systemic risk, suggesting important negative externalities associated with the syndication process.
This paper studies the interconnectedness of banks in the syndicated loan market as a major source of systemic risk. We develop a set of novel measures to describe the "distance" (similarity) between two banks'syndicated loan portfolios and …nd that such distance explains how banks are interconnected in this market. As lead arrangers choose to work with those that have a similar focus in terms of lending expertise, there is a high propensity of bank lenders to concentrate syndicate partners rather than to diversify them. We …nd some evidence of potential bene…ts of this behavior as to lower costs of screening and monitoring, for example, higher shares of the loan taken by more connected lenders and lower loan spreads if syndicated lenders are more connected.Lastly, we …nd that the most heavily interconnected lenders in the syndicated loan market are also the greatest contributors to systemic risk, suggesting important negative externalities associated with the syndication process.
Competition or Collaboration? The Reciprocity Effect in Loan Syndication by Jian Cai It is well recognized that loan syndication generates a moral hazard problem by diluting the lead arranger's incentive to monitor the borrower. This paper proposes and tests a novel view that reciprocal arrangements among lead arrangers serve as an effective mechanism to mitigate this agency problem. Lender arrangements in about seven out of ten syndicated loans are reciprocal in the sense that lead arrangers also participate in loans that are led by their participant lenders. Syndicate lenders share reciprocity through such arrangements as they can mutually benefi t from each other's monitoring effort. In fear of losing this reciprocity, lead arrangers will dutifully monitor their borrowers. Loans arranged in such a reciprocal way thus feature reduced moral hazard. I fi nd strong empirical evidence that is consistent with the reciprocity effect. Controlling for lender, borrower, and loan characteristics, I show that: (i) lead arrangers retain on average 4.3% less of the loans with reciprocity than those without reciprocity, (ii) the average interest spread over LIBOR on drawn funds is 11 basis points lower on loans with reciprocity, and (iii) the default probability is 4.7% lower among loans with reciprocity. These results indicate a cooperative equilibrium in loan syndication and have important implications to lending institutions, borrowing fi rms, and regulators.
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