Loan Sales and the Cost of Bank Capital
This paper demonstrates that if banks are faced with significant competition for deposit financing, as well as regulatory constraints in the form of required capital and/or reserves, banks cannot be profitable solely by holding marketable assets. They must provide other services, such as information gathering and monitoring activities related to making loans. For a bank which originates loans, loan selling will likely provide a cheaper source of funds than traditional deposit or equity finance. However, the extent to which banks can sell loans is limited by the ability of the bank--loan buyer contract to overcome a moral hazard problem. The bank’s choice of an optimal loan sales contract is analyzed with and without allowance for recourse.
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