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Bank loans versus bond finance: implications for sovereign debtors

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  • Misa Tanaka

Abstract

This paper develops a model to analyse the optimal choice between bank loans and bond finance for a sovereign debtor. We show that if banks have better information about their borrowers compared to bondholders, only the least risky sovereigns issue bonds. But if borrowers can be 'publicly monitored' by an outside agency that disseminates the information about their creditworthiness, their choice between bank loans and bond finance is determined endogenously by the trade-off between two deadweight costs: the crisis cost of a sovereign default and the cost of debtor moral hazard. In equilibrium, sovereigns use bank loans for financing short-term projects and bond issuance for projects with uncertain timing of cash flows if crisis costs are large. We also demonstrate that state-contingent debt and IMF intervention can improve welfare.

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Paper provided by Bank of England in its series Bank of England working papers with number 267.

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Date of creation: Jul 2005
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Handle: RePEc:boe:boeewp:267

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  1. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  2. Stephen Morris & Hyun Song Shin, 1999. "Coordination Risk and the Price of Debt," Cowles Foundation Discussion Papers 1241R, Cowles Foundation for Research in Economics, Yale University, revised Feb 2002.
  3. Mark M. Spiegel, 2000. "Solvency runs, sunspot runs, and international bailouts," Working Paper Series 2001-05, Federal Reserve Bank of San Francisco.
  4. Eduardo Borensztein & Paolo Mauro, 2002. "Reviving the Case for GDP-Indexed Bonds," IMF Policy Discussion Papers 02/10, International Monetary Fund.
  5. Michael P. Dooley, 2000. "Can Output Losses Following International Financial Crises be Avoided?," NBER Working Papers 7531, National Bureau of Economic Research, Inc.
  6. Haldane, Andrew G. & Penalver, Adrian & Saporta, Victoria & Shin, Hyun Song, 2005. "Analytics of sovereign debt restructuring," Journal of International Economics, Elsevier, vol. 65(2), pages 315-333, March.
  7. Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, vol. 47(4), pages 1367-400, September.
  8. Bolton, Patrick & Scharfstein, David S, 1996. "Optimal Debt Structure and the Number of Creditors," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 1-25, February.
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Cited by:
  1. Irwin, Gregor & Thwaites, Gregory, 2008. "Efficient frameworks for sovereign borrowing," Bank of England working papers 343, Bank of England.
  2. Sayantan Ghosal & Kannika Thampanishvong, 2007. "Does Strengthening Collective Action Clauses (CACs) Help?," CDMA Working Paper Series 200711, Centre for Dynamic Macroeconomic Analysis, revised 15 Oct 2007.

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