Loan Pricing Research Articles

The Impact of CEO IT Ability on Bank Loan Terms

ABSTRACT Although the role that information technology (IT) executives’ expertise has in firm outcomes is well documented, little empirical work investigates the effect of the IT ability of non-IT executives on firm outcomes. We apply upper echelons theory and create a unique measure of chief executive officer (CEO) IT ability to empirically investigate its impact on bank loan pricing and nonpricing terms. Examining a sample of firms between 2002 and 2017, we find that CEO IT ability is associated with lower cost of debt, less collateral, fewer loan covenants, and fewer credit rating downgrades. Further, we show that our results are not due to high tech firms and are incremental to firm-level IT capability. Our results extend upper echelons theory and suggest that IT ability is an important CEO characteristic that can be influential in improving lending outcomes.

Functional distance and bank loan pricing: Evidence from the opening of high-speed railway in China

Employing the staggered opening of the High-speed railway (HSR) as an exogenous shock, this paper examines the impact of functional distance on bank loan pricing. Based on a unique loan-level dataset from a nationwide state-owned Chinese commercial bank, we find that after the HSR opening, the loan pricing of local private firms decreases significantly. The possible channel is the facilitating of bank's easier access to soft information through the shortening of temporal functional distance. Moreover, the effect of HSR opening is more pronounced when the borrowing firm is difficult to visit or when loan pricing is more sensitive to information. We also find that the HSR opening increases the loan volume for local private firms, while there are no significant changes in loan pricing or loan volume for public firms with HSR opening. Our main conclusion remains valid after considering various robustness and endogeneity issues.

A risk-neutral approach to the RAROC method of loan pricing using account-level data

PurposeThis paper has used account-level data of corporate and retail borrowers, assessed their credit risk through the risk-neutral principle and examined its implication on loan pricing.Design/methodology/approachIt derives the capital charge and credit risk-premium for expected and unexpected losses through a risk-neutral approach. It estimates the risk-adjusted return on capital as the pricing principle for loans. Using GMM regression, the article has assessed the determinants of risk-based pricing.FindingsIt has been found that risk-premium is not reflected in the current loan pricing policy as per Basel II norms. However, the GMM estimation on RAROC can price risk premium and probability of default, LGD, risk weight, bank beta and capital adequacy, which are the prime determinants of loan pricing. The average RAROC for retail loans is more than that of corporate loans despite the same level of risk capital requirement for both categories of loans. The robustness tests indicate that the RAROC method of loan pricing and its determinants are consistent against the time and type of borrowers.Research limitations/implicationsThe RAROC method of pricing effectively assesses the inherent risk associated with loans. Though the empirical findings are confined to the sample bank, the model can be used for any bank implementing the Basel principle of risk and capital assessments.Practical implicationsThe article has developed and validated the model for estimating RAROC, as per Basel II guidelines, for loan pricing that any bank can use.Social implicationsIt has developed the risk-based loan pricing model for retail and corporate borrowers. It has significant practical utility for banks to manage their risk, reduce their losses and productively utilise the public deposits for societal developments.Originality/valueThe article empirically validated the risk-neutral pricing principle using a unique 1,520 retail and corporate borrowers dataset.

Does New Lease Accounting Standard ASC 842 Affect Bank Loan Pricing?

Does New Lease Accounting Standard ASC 842 Affect Bank Loan Pricing?

Corporate Green Revenues and Syndicated Loan Pricing

Corporate Green Revenues and Syndicated Loan Pricing

The Feedback Effect: Evidence from Bank Loan Pricing

The Feedback Effect: Evidence from Bank Loan Pricing

Proxy contests and debt contracting behavior: The interplay of managerial, shareholder and creditor incentives

AbstractWe evaluate how heterogeneity in the strategic interplay among shareholder, creditor and manager incentives influences debt contracting behavior around proxy contests. We find that, after proxy contests, new loan originations have significantly higher spreads and more stringent non‐pricing contracting terms. The effect, however, occurs largely in contest firms where Chief Executive Officers (CEOs) are provided with risk‐taking incentives. Further, creditors’ simultaneous equity holdings and credit default swaps (CDS) trading attenuate the impact of proxy contests on debt contracting costs. Finally, proxy contests that culminate in voting and dissident victory experience the largest increase in loan pricing. Overall, our results suggest an increase in the agency cost of debt occurs after proxy contests, particularly when managerial risk‐taking incentives are high, and when creditors do not simultaneously hold target firms’ equity or CDS.

Alternative risk measurement for the banking system and its nexus with economic growth

Scientific and reasonable evaluation of bank performance can help them conduct business management and decision-making, while most research ignore using the shadow price of undesirable outputs to evaluate banking performance. This study introduces a dual formulation of network data envelopment analysis to evaluate the shadow price of non-performing loans, which could be regarded as a novel measure of potential financial risk. We further investigate the tradeoff between economic growth and financial risk from micro and macro perspectives. Our results show that the financial risk of city commercial banks and joint-stock banks is higher than that of the big four state-owned and policy banks. Our research proves that economic growth influences the risk levels of banks directly and indirectly. More specifically, our study confirms that economic growth can reduce the bank's risk by reducing the bank's loan capital ratio as an intermediary path, that an increase in the capital adequacy ratio has a positive effect on the bank's risk.

New Transfer Pricing Guidance in the Netherlands on Intra-Group Pricing of Financial Transactions – An Analysis of Potential Implications

The authors analyse the impact of the new 2022 Dutch transfer pricing decree on financial transactions and specifically on the pricing of intra-group loans and financial services companies (so-called financial intermediaries). Particular attention is paid to the role of control over financial risks and the concept of financial capacity. The analysis reveals several attention points that can have an immediate and significant impact on taxpayers involved in such financial intra-group transactions.

Borrower- and lender-specific determinants in the pricing of sustainability-linked loans

The financial industry has developed a wide breadth of instruments to support the growing number of firms interested in socially responsible, or “sustainable”, investing. The use of the most well-known, green bonds, is generally limited to investments defined by the Green Bond Principles. However, more flexible sustainability-linked loans (SLLs) have skyrocketed in importance recently. In 2021, they became the largest corporate debt type including a sustainable feature, raising USD 735 billion globally. Existing evidence on the potential lower yields of green bonds, also known as the greenium, supports their attractiveness from a borrower's perspective. Contrary to this evidence, however, little is yet known about the financial attractiveness of SLLs. We address this research gap, and provide new findings on the yields of sustainability-linked loan financing. We study 121 SLLs originated in 2021, and compare them to peers of matched conventional loans featuring similar characteristics. We find that SLLs are associated with lower initial yields for borrowers. This benefit is more pronounced for borrowers with strong environmental profiles, and for loan originations conducted using a lender syndicate with high environmental standards. The financial benefits, coupled with their flexible structure, suggest that SLLs can be an attractive tool for companies from a variety of sectors to use in managing sustainable business transformations and addressing the challenges of climate change.

Nonparametric shadow pricing of non-performing loans: a study of the Chinese banking sector

Nonparametric shadow pricing of non-performing loans: a study of the Chinese banking sector

Risk-Adjusted Loan Pricing

We analyze what are the main pricing components for performing loans. By exploiting a survey conducted by the authors in AIFIRM (2021), we provide empirical evidence about whether and to what extent various pricing criteria are related to interest income within the internal model framework. Our main findings are that banks’ interest income is positively related to the adoption of advanced internal risk-based models, the calculation of the break-even rate, and the implementation of the risk-adjusted profitability measures in the pricing, while it is negatively linked to higher market competition, a decentralized pricing function (allowing more customeroriented loans prices). The results make urgent to monitor and develop improve current risk models to support both central offices and the sales network in the process of formulating loan prices and monitoring the value consequently created.

Effect of climate-related risk on the costs of bank loans: Evidence from syndicated loan markets in emerging economies

Based on a novel dataset that combined syndicated loans originated in the emerging market economies with greenhouse gas emission intensity data of borrowers, this study examines whether and to what extent banks in these emerging markets have factored in climate transition risk in their lending decisions. On loan pricing, our results suggest that banks in these emerging markets have started to price-in climate transition risk for loans to emissions-intensive sector since the Paris Agreement. This could reflect their increased awareness of a climate-transition risk towards such firms. The extent of the transition risk premium is also found to be dependent on the environmental attitude of banks. Specifically, green banks are found to charge a higher loan spread than other banks, when lending to the same brown firm after the Paris Agreement. Apart from pricing a transition risk premium in the loan spread, we find evidence that banks may also consider imposing more stringent non-pricing contractual terms, such as shortening loan tenor and imposing collateral requirement, on brown firms especially when the associated credit risk impacts on these firms are more uncertain.

Risk mitigation effect of foreign debt: evidence from loan pricing

PurposeThe author examines the presence of foreign currency effects and the risk-mitigation channel through which a foreign-currency denomination reduces the loan spread.Design/methodology/approachThe author runs regression analyses using loan data of firms incorporated in member countries of the Association of Southeast Asian Nations (ASEAN) from 2000 to 2020. The author also runs several robustness tests to address forward exchange rate bias, endogeneity concern and sample-selection bias.FindingsConsistent with the currency matching motive of foreign debt use, the results show that a foreign currency denomination is associated with a lower spread and the relationship is amplified when there is a positive correlation between the changes in the return on assets and in the exchange rate.Research limitations/implicationsThis paper enriches existing studies on the use of foreign debt as an exchange rate risk management tool.Practical implicationsThe results suggest that as firms utilize foreign debt and policymakers need to design banking regulations that not only oversee but also encourage the use of foreign debt as a hedging instrument to lower firms' borrowing costs.Originality/valueThis paper contributes to extant studies by examining the presence of foreign currency effects in emerging countries' loan markets and by exploiting the micro-level demand-side factors as the channel through which the currency denomination affects the loan spread.

Effect of M-Shwari Loan Pricing on Uptake of Loans from NCBA in Meru County

In the last decade, Kenya has witnessed remarkable growth in digital lending products and platforms. However, the impact of these digital lending products on uptake of loans remains under-researched. The purpose of the study was to determine the effects of M- Shwari loan pricing on uptake of loans from NCBA Bank Kenya PLC in Meru County. The study was guided by the financial intermediation theory. The study adopted a descriptive survey research design. The target population was NCBA Bank Kenya PLC Meru Branch customers who utilize the bank's M-Shwari digital credit. The sample size was 380 respondents who were selected using a simple random sampling technique. Quantitative data was analyzed through descriptive and inferential statistics. Qualitative data was analyzed thematically using conceptual content analysis. The study found that M-Shwari’s loan pricing was negatively and significantly related to the uptake of bank loans. The study concluded that M-Shwari’s loan pricing had a negative and significant relationship with uptake of bank loans among NCBA Bank Kenya PLC customers in Meru County. The study recommends that NCBA Bank Kenya PLC managers should charge lower interest to their customers, and should create awareness among their customers on considerations made in credit scoring of digital loans customers.

Impact of mortgage soft information in loan pricing on default prediction using machine learning

AbstractWe analyze the impact of soft information on US mortgages for default prediction and provide a new measure for lender soft information that is based on the interest rates offered to borrowers and incremental to public hard information. Hard and soft information provide for a variation in annual default probabilities of approximately 3%. Soft information has a lesser impact over time and time since origination. Lenders rely more on soft information for high‐risk borrowers. Our study evidences the importance of soft information collected at loan origination.

Are all types of real transaction management equal in the eyes of bank lenders?

AbstractThis study examines whether bank lenders react differently to various types of real transaction management (RTM) by borrowing firms. Drawing upon the differential cash and cash flow effects of alternative forms of RTM, we predict and find that banks provide more favorable loan terms, that is, lower interest spread and reduced likelihood of required collateral, for firms reporting more discretionary reductions in research and development (R&D) expenditures. In contrast, lending banks respond unfavorably to borrowers’ engagement in RTM through aggressive sales discounts and overproduction of inventories. Additional analysis reveals that the favorable effect of discretionary R&D reductions on loan pricing is greater (smaller) for borrowing firms with a prior relationship with the bank or with a lower level of cash holdings (loans with longer maturity). Overall, our findings suggest that banks, with their unique payoff functions and monitoring incentives, do not view all forms of RTM negatively.

What firm risk factors drive bank loan pricing and other terms? Evidence from China

AbstractThis study investigates how firm risk factors affect bank loan pricing. Although firm‐specific stock price crash risk affects bank loan costs directly, it also prompts other risks, including financial restatement and litigation, which in turn trigger higher bank loan costs. Strong internal and external governance mechanisms help reduce agency problems and improve information transparency, alleviating the adverse effect of stock price crash risk on loan costs. Our results confirm that bankers take good corporate governance into account in their bank loan decisions. We also show that bond investors price the adverse effect of stock price crash risk, prompting higher corporate bond costs. Futher evidence suggests that banks impose stricter non‐price terms, such as smaller loan size, shorter loan maturity, and a higher likelihood of collateral requirement, on firms with higher crash risk.

Mitigating credit risk: modelling and optimizing co-insurance in loan pricing

ABSTRACT Despite large-scale financial development and banks being the most important credit source globally, banking continues to be plagued by asymmetric information. This uncertainty makes credit risk assessment decisions complex and expensive. In this context, we show how discretionary borrower characteristics, such as the borrower’s network (which can co-insure), help mitigate risk and reduce costs by altering lending decisions. The literature on loan pricing remains focused on objective credit scoring models, while the network literature remains empirical, and borrower based. We fill this void by being the first to theoretically model the lender’s internal decision-making problem when borrowers display discretionary default risk-mitigating attributes such as network strength. We find that the interest rate reduces as the network strength increases. As constraints set in and borrowing becomes more competitive, banks rely even more on network information to parse out better borrowers. Finally, banks substitute monitoring effort with network strength for a more feasible interest rate. This will increase lending, even to borrowers outside the banks’ purview earlier.

Determinants of Syndicated Loan Spreads in Central, Eastern and South-Eastern European Countries

Despite the importance of the syndicated loan market as a source of international financing there is limited evidence on factors influencing syndicated loan pricing in European developing economies. Focusing in one particular region reduces the problem of cross-country heterogeneity and provides more specific policy recommendations for reducing the cost of funding for firms, in an environment where capital markets are less developed, and banks are seen as the main source of funding. This study investigates the determinants of syndicated loan spreads in a sample of 1004 syndicated loans from the Thomson One Banker database, granted to borrowers from 12 Central, Eastern and South-Eastern European countries. The results show that loan and country characteristics are the most significant determinants of syndicated loan spreads. Lenders seem to price loan characteristics in European transition economies in accordance with the existing academic literature – riskier loans are charged higher spreads. Augmenting the Thomson One Banker with the Worldscope database, we further find that borrower characteristics are generally significant determinants of syndicated loan spreads however their significance weakens once country characteristics are taken into account. Lender characteristics are found not to be significant determinants of syndicated loan spreads in European transition economies. The implication of these results is that governments of European transition countries have a major role to play in providing a macro-economic and legal infrastructure that will enable borrowing firms to get access to funding sources at lower spreads. Keywords: syndicated loans, spreads, emerging Europe, Thomson One Banker, Worldscope DOI: 10.7176/JESD/13-18-02 Publication date: September 30 th 2022