Loan Sales and the Cost of Bank Capital

Authors

  • GEORGE G. PENNACCHI

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    • Department of Finance, University of Pennsylvania. I am grateful for useful comments from the participants of seminars at the University of Pennsylvania, the Conference on Asset Securitization at Northwestern, and the European Finance Meetings in Madrid, Spain. Comments by Franklin Allen, Mitchell Berlin, Michael Fishman, Joseph Haubrich, Robert Litzenberger, David Pyle, Krishna Ramaswamy, Michael Smirlock, and an anonymous referee are also appreciated. Funding was provided by the Herbert V. Prochnow Educational Foundation of the Graduate School of Banking, Madison, Wisconsin.

ABSTRACT

This paper considers a model where banks may improve the returns on loans by monitoring borrowers. Bank regulation, together with competitive deposit and equity financing, can give banks an incentive to sell loans, but the extent of their loan selling is limited by a moral-hazard problem. A solution is given for the optimal design of the bank-loan buyer contract that alleviates this moral-hazard problem. An explanation is also given as to why some banks might buy loans and why loan sales volume has recently increased.

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