Tying loan interest rates to borrowers' CDS spreads

RePEc Short ID: psa250
ORCID iD: 0000-0002-6002-5969

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

Working Paper

Tying loan interest rates to borrowers' CDS spreads

Abstract: 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.

Keywords: Market-based pricing; loan spreads; loan covenants; CDS spreads;

JEL Classification: G10; G21; G30;