Moral hazard and adverse selection in the originate-to-distribute model of bank credit

How Do Lead Banks Use Their Private Information about Loan Quality in the Syndicated Loan Market?

“…With no private information, it would not be possible to signal uninformed potential investors about 5 The Signaling Hypothesis is also analogous to some theories of collateral in which borrowers with favorable private information pledge collateral to signal their quality to differentiate themselves from lower-quality borrowers (e.g., Bester, 1985Bester, , 1987Thakor, 1987a, 1987b;Chan and Thakor, 1987;and Boot, Thakor, and Udell, 1991).…”

“…Intuitively, this is similar to Leland and Pyle's (1977) separating equilibrium in which entrepreneurs with private information about project quality invest more of their own funds in projects with higher quality. 5 Signaling is costly to the lead bank in terms of tying up funds, but it allows the market to clear in the presence of asymmetric information. Lead banks may also signal private information through loan pricing.…”

Are There Non-linear Effects of Banking Relationships and Ownership Concentration on Operational Performance? Empirical Evidence from Portuguese SMEs Using Cross-section Analysis and Panel Data

“…This leads to adverse selection which prevents banks from practicing active differentiated interest rates and credit contracts adjusted to the risk level of the applicants. The difficulty in distinguishing "good" companies from "bad" ones creates the first obstacles to credit access increased by the significant presence of the latter (Berndt andGupa, 2009, Ivashina, 2009). Moreover, the creditor bank may find difficult to control the company's behavior after celebrating the credit agreement, causing so-called moral hazard (Torre et al, 2010).…”

“…Adverse selection promotes an increase in the interest rate and causes two effects of conflicting signals about the bank's expected return: on the one hand, in the case of customers servicing their debt, expected return is seen to increase; on the other hand, in the case of default, risk increases and the return decreases (Stiglitz and Weiss, 1981). From a certain amount, the second effect overrides the first in which an increase in the interest rate leads to a decrease in the bank's return (Berndt andGupta, 2009, Bharath et al, 2011). Under these circumstances, the bank no longer has incentives to increase the interest rate, preferring instead to ration credit.…”

“…The results suggest that the problems of adverse selection and moral hazard lead the bank to require a priori interest rates, higher collateral and more restrictive contractual terms. This problem leads many companies to forego good investment opportunities, conditioning its operating profitability (Parlour and Plantin, 2008, Berndt and Gupa 2009, Degryse et al, 2011. To the extent that the company can establish stable relationships, negotiating flexibility is improved, control exerted by the credit entity is increased, its reputation and confidentiality develops, and can thereby optimize decisions and increase expected returns (Ongena andSmith, 2000, Cánovas andSolano, 2010 As for the effect of the control variables on operating profitability, the results show that they all have a statistically significant effect on the dependent variable.…”