Benign neglect of covenant violations: Blissful banking or ignorant monitoring?
Michael Koetter and
No 3/2019, IWH Discussion Papers from Halle Institute for Economic Research (IWH)
Theoretically, bank's loan monitoring activity hinges critically on its capitalisation. To proxy for monitoring intensity, we use changes in borrowers' investment following loan covenant violations, when creditors can intervene in the governance of the firm. Exploiting granular bank-firm relationships observed in the syndicated loan market, we document substantial heterogeneity in monitoring across banks and through time. Better capitalised banks are more lenient monitors that intervene less with covenant violators. Importantly, this hands-off approach is associated with improved borrowers' performance. Beyond enhancing financial resilience, regulation that requires banks to hold more capital may thus also mitigate the tightening of credit terms when firms experience shocks.
Keywords: bank monitoring; covenant violations; syndicated loans; business cycle (search for similar items in EconPapers)
JEL-codes: G21 G32 G33 G34 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-bec and nep-cfn
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:iwhdps:32019
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