Credit Risk Transfer, Delegated Monitoring, Real Sector Productivity, and Financial Deepening

Abstract

We examine the effect which credit risk transfer (CRT) markets have on real sector productivity and the volume of financial intermediation in an economy. We find that, despite a reduction in per-firm monitoring, CRT increases productivity in the up-market segment of the real sector but decreases at the lower end. Also, we find that CRT, if optimal, unambiguously fosters financial deepening, that is, it leads to more financial intermediation in the sense that otherwise credit-rationed firms receive access to outside funding. These overall positive effects, however, rely upon the ability of banks to overcome a new type of moral hazard, namely to commit to the optimal amount of CRT. This stems from the fact that a time inconsistency problem arises after deposit contracts are written. Finally, our model predicts that CRT origination should be observed less for high moral hazard loans, for countries where banks are more involved in firms' corporate governance, and for small, regional banks specialized in relationship-intensive loans.