Bank Loans Versus Bond Finance: Implications for Sovereign Debtors

Misa Tanaka

Economic Journal, 2006, vol. 116, issue 510, pages C149-C171

Abstract: This article analyses the optimal choice between bank loans and bond finance for a sovereign debtor. It shows that if borrowers can be 'publicly monitored' by a rating agency that disseminates the information about their creditworthiness, their choice between bank loans and bond finance is determined by the trade-off between two deadweight costs: the crisis cost of default and the cost of debtor moral hazard. If crisis costs are large, sovereigns use bank loans for short-term financing and bond issuance for long-term financing. I also demonstrate that state contingent debt and IMF intervention can improve welfare. Copyright 2006 Bank of England.

Date: 2006

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