Loan Sales and Relationship Banking

TLDR

Firms raise capital through banks and bonds, while banks sell loans in a secondary market to recycle funds or exploit private information, and loan market liquidity—shaped by trade motives—affects firms’ optimal financial structure. The study offers testable predictions for prices and quantities in primary and secondary loan markets and bond markets, and argues that risk‑based capital requirements could be socially beneficial. The authors derive testable implications for prices and quantities in primary and secondary loan markets and bond markets. The study finds that endogenous liquidity is suboptimal, with excessive trade in highly rated bonds and insufficient liquidity for riskier ones.

Abstract

ABSTRACT Firms raise money from banks and the bond market. Banks sell loans in a secondary market to recycle their funds or to trade on private information. Liquidity in the loan market depends on the relative likelihood of each motive for trade and affects firms' optimal financial structure. The endogenous degree of liquidity is not always socially optimal: There is excessive trade in highly rated names, and insufficient liquidity in riskier bonds. We provide testable implications for prices and quantities in primary and secondary loan markets, and bond markets. Further, we posit that risk‐based capital requirements may be socially desirable.