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The Pricing of Sequential Bank Loans

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  • Manoj Athavale
  • Robert O. Edmister

Abstract

The theory of financial intermediation assigns banks a unique role in the resolution of information asymmetry. Banks, in general, obtain private information about the borrower and the project during the screening of loan applicants and during the monitoring of loan recipients. Incumbent banks, in particular, utilize information obtained while monitoring previous loan extensions to resolve information asymmetry when granting subsequent loans. We examine the rate on a sequence of loans to a borrower and find that the incumbent bank information advantage has finite magnitude and is quickly reflected in the pricing of the second loan. We also find that the lending relationship does not deteriorate to the detriment of the borrower. This study also provides further evidence supporting the hypothesis that an incumbent bank resolves information asymmetry during the monitoring of loan extensions.

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  • Manoj Athavale & Robert O. Edmister, 2004. "The Pricing of Sequential Bank Loans," The Financial Review, Eastern Finance Association, vol. 39(2), pages 231-253, May.
    • Handle: RePEc:bla:finrev:v:39:y:2004:i:2:p:231-253
    DOI: 10.1111/j.0732-8516.2004.00074.x
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    4. Chateau, J.-P. & Wu, J., 2007. "Basel-2 capital adequacy: Computing the `fair' capital charge for loan commitment `true' credit risk," International Review of Financial Analysis, Elsevier, vol. 16(1), pages 1-21.
    5. Chateau, John-Peter D., 2007. "Beyond Basel-2 simplified standardized approach: Credit risk valuation of short-term loan commitments," International Review of Financial Analysis, Elsevier, vol. 16(5), pages 412-433.

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