Relationship between Banks’ Capital and Credit Risk-Taking through Syndicated Loan

Jun Lu,Shu Ling Lin,Wei Peng Chen

doi:10.4236/me.2015.612123

Abstract

This paper aims to investigate whether banks exploit their information advantage over bank-dependent borrowers, analyzing the impact of capital level on banking credit risk-taking under syndication loans. By using a unique data composed of 4828 syndicated loan of publicity banks facilities from the U.S. for the period 1987-2010, we propose theoretical issues of the impact and effectiveness of banks’ credit risk-taking from the perspectives of borrowers’ bank dependent. The results show that there is positive correlation between the ratios of bank’s capital over its total assets and banks’ credit risk-taking. It implies that banks with lower capital level charge higher lending spread for borrowers with fewer cash flows; hence the banks would bear a lower probability of default.

Highlights

Since the subprime mortgage crisis began in 2007, bank with low capital led to significant cutbacks in lending caused by huge credit crunches
To test the robustness and determine whether other controlled variables might impact of bank capital on risktaking, this study considers additional controlling variables for lending bank and loan and bank-specific characteristics, and proposes the following hypotheses: H2 : Controlling for the state of the loan-specific characteristics, banks with lower capital level charge higher lending spread for borrowers with fewer cash flows; banks with low capital would obtain higher return and bear a lower probability of default
The result shows that compared to adequately capitalized banks, banks with lower capital level charge higher lending spread for borrowers with fewer cash flows, the banks would bear a lower probability of default and credit risk-taking, but higher credit risk for borrowers with strong cash flows

Summary

Introduction

Since the subprime mortgage crisis began in 2007, bank with low capital led to significant cutbacks in lending caused by huge credit crunches. It is critically important for authorities to better understand the relation between bank capital levels and lending behavior, and seek to oversee the stability and its impact on the wider financial system. Existing studies on the effect of the banks’ lending behavior have begun to draw more attention recently, but the consequences on banks’ credit risk-taking have been relatively scarce. Several theories advocate that a banks’ capital level should affect their lending behavior (2015) Relationship between Banks’ Capital and Credit Risk-Taking through Syndicated Loan. Sharpe [3] and Rajan [4] propose successively the theories on banks’ information monopoly; and predict that banks with low capital should charge higher lending rates to borrowers that are more bank-dependent. Banks with low capital would obtain higher return and take lower risk. Diamond and Rajan [6] argue that banks with low capital much focus on obtaining cash flow quickly, they may charge more to borrowers with low cash flow; give large discounts to borrowers with high cash flow

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