Federal Dposit InsuranceCorporation• Center for Financial Researchh
Sanjiv R. Das
Darrell Duffie
Nikunj Kapadia
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
FDIC Center for Financial Research
Working Paper
No. 2012-01
The Supply-Side Determinates of Loan Contract Strictness
November 2011
Empirical Comparisons and Implied Recovery Rates
kkk
An Empirical
An Empirical Analysis
State-
Efraim Benmel Efraim Benmelech May, 2005
June 20
May , 2005 Asset S2005-14
September 2005
Sanjiv R. Das
Darrell Duffie
Nikunj Kapadia
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
Risk-Based Capital Standards,
Deposit Insurance and Procyclicality
FDIC Center for Financial Research
Working Paper
No. 2012-01
The Supply-Side Determinates of Loan Contract Strictness
November 2011
Empirical Comparisons and Implied Recovery Rates
kkk
An Empirical
An Empirical Analysis
State-
Efraim Benmel Efraim Benmelech May, 2005
June 20
May , 2005 Asset S2005-14
September 2005
The Supply-Side Determinants of Loan Contract
Strictness
Justin Murfin ∗
Yale University
November 7, 2011
Abstract
Using a novel measure of contract strictness based on the ex-ante probability of a covenant violation, I
investigate how lender-specific shocks impact the strictness of the loan contract that a borrower receives.
Exploiting between-bank variation in recent portfolio performance, I find evidence that banks write tighter
contracts than their peers after suffering payment defaults to their own loan portfolios, even when defaulting
borrowers are in different industries and geographic regions than the current borrower. The effects of
recent defaults persist after controlling for bank capitalization, although compression in bank equity is also
strongly associated with tighter contracts. The evidence is most consistent with lenders using their default
experience to make inference about their screening ability and adjusting contracts accordingly. Finally,
contract tightening is most pronounced for borrowers who are dependent on a relatively small circle of lenders,
with a one standard deviation increase in lender defaults implying covenant tightening nearly equivalent to
that of a two-notch downgrade in the borrower’s own credit rating.
∗email:justin.murfin@yale.edu. I am particularly grateful to my dissertation chair, Manju Puri, for guid-
ance and support. This paper also benefited greatly from the suggestions of Mitchell Petersen (the acting
editor), two anonymous referees, Ravi Bansal, Alon Brav, Murillo Campello, Scott Dyreng, Simon Ger-
vais, John Graham, Kenneth Jones, Andrew Karolyi, Felix Meschke, Adriano Rampini, Phil Strahan, David
Robinson, Anjan Thakor, Vish Viswanathan, Andrew Winton, and seminar participants at Cornell Uni-
versity, Duke University, Drexel University, Kansas University, Notre Dame, NYU, University of Illinois,
University of Utah, University of Virginia, Washington University, Yale University, the WFA, the NBER,
and the FDIC Center for Financial Research. I acknowledge financial support from the FDIC Center for
Financial Research.
Strictness
Justin Murfin ∗
Yale University
November 7, 2011
Abstract
Using a novel measure of contract strictness based on the ex-ante probability of a covenant violation, I
investigate how lender-specific shocks impact the strictness of the loan contract that a borrower receives.
Exploiting between-bank variation in recent portfolio performance, I find evidence that banks write tighter
contracts than their peers after suffering payment defaults to their own loan portfolios, even when defaulting
borrowers are in different industries and geographic regions than the current borrower. The effects of
recent defaults persist after controlling for bank capitalization, although compression in bank equity is also
strongly associated with tighter contracts. The evidence is most consistent with lenders using their default
experience to make inference about their screening ability and adjusting contracts accordingly. Finally,
contract tightening is most pronounced for borrowers who are dependent on a relatively small circle of lenders,
with a one standard deviation increase in lender defaults implying covenant tightening nearly equivalent to
that of a two-notch downgrade in the borrower’s own credit rating.
∗email:justin.murfin@yale.edu. I am particularly grateful to my dissertation chair, Manju Puri, for guid-
ance and support. This paper also benefited greatly from the suggestions of Mitchell Petersen (the acting
editor), two anonymous referees, Ravi Bansal, Alon Brav, Murillo Campello, Scott Dyreng, Simon Ger-
vais, John Graham, Kenneth Jones, Andrew Karolyi, Felix Meschke, Adriano Rampini, Phil Strahan, David
Robinson, Anjan Thakor, Vish Viswanathan, Andrew Winton, and seminar participants at Cornell Uni-
versity, Duke University, Drexel University, Kansas University, Notre Dame, NYU, University of Illinois,
University of Utah, University of Virginia, Washington University, Yale University, the WFA, the NBER,
and the FDIC Center for Financial Research. I acknowledge financial support from the FDIC Center for
Financial Research.