Theoretically, bank's loan monitoring activity hinges critically on its capitalization. To proxy for monitoring intensity, we use changes in borrowers' investment following loan covenant violations, when creditors can intervene in the governance of the firm. Exploiting granular bank-firm relationships observed in the syndicated loan market, we document substantial heterogeneity in monitoring across banks and through time. Better capitalized banks are more lenient monitors that intervene less with covenant violators. Importantly, this hands-off approach is associated with improved borrowers' performance. Beyond enhancing financial resilience, regulation that requires banks to hold more capital may thus also mitigate the tightening of credit terms when firms experience shocks.
The responsibility for discussion papers lies solely with the individual authors. The views expressed herein do not necessarily represent those of IWH. The papers represent preliminary work and are circulated to encourage discussion with the authors. Citation of the discussion papers should account for their provisional character; a revised version may be available directly from the authors. Comments and suggestions on the methods and results presented are welcome.
This paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB.
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