Bank Forward Lending in Alternative Funding Environments

Deshmukh, S. D.; Greenbaum, Stuart I.; Kanatas, George

doi:10.2307/2327758

Cited by 16 publications

(11 citation statements)

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“…Thus, the equilibrium R + and R-are the results of a joint process that impounds, on an expectational basis, conditions in the forward market as well as the aggregate supply and demand for funds at t=2. This presents obvious difficulties for monetary policy aimed at controlling aggregate variables [see Deshmukh, Greenbaum and Kanatas (1982)]. Ours, however, is strictly a partial equilibrium exercise that focuses on bilateral bank-borrower relation:hips in a competitive market.…”

Section: Pricing Under Perfect Informationmentioning

confidence: 99%

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An economic rationale for the pricing structure of bank loan commitments

Thakor

Udell

1987

Journal of Banking & Finance

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Section: Pricing Under Perfect Informationmentioning

confidence: 99%

“…This has caused a concomitant surge of interest in the theoretical literature. Some writers have emphasized the role that loan commitments may play in the mechanics of monetary policy [for example, Deshmukh, Greenbaum and Kanatas (1982)]. However, most of the recent literature has focused on pricing issues [for example, Hawkins (1982)].…”

Section: Introductionmentioning

confidence: 99%

An economic rationale for the pricing structure of bank loan commitments

Thakor

Udell

1987

Journal of Banking & Finance

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“…In that case, option valuation methods may be applied to the pricing problem. This is the approach of Deshmukh, Greenbaum, and Kanatas [4]. It is not suitable, however, for cases with a floating prime-based interest rate (cf.…”

Section: Loan Commitment Contracts: An Institutional Backgroundmentioning

confidence: 99%

“…The risk premium markup is a borrowerspecific loan price component, as is the loan commitment fee. 4 Under the contract, the borrower must decide how large a liability he will have at any period t, 0 < t < T. This liability, Lt, is non-negative and must never exceed L*. In each period, t, the borrower must pay rt + m in interest on Lt, where rt is the instantaneous prime rate prevailing at t. The borrower will select Lt based on his own maximizing considerations, which for now will remain nonspecified.…”

Section: A Model Of Loan Term "Packages"mentioning

confidence: 99%

Loan Commitment Contracts, Terms of Lending, and Credit Allocation

Melnik¹,

Plaut²

1986

The Journal of Finance

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This paper analyzes the structure of loan commitment contracts and the interrelationships among their component parameters. Lenders offer borrowers a set of loan "packages," from which the latter may choose that "package" found to be most appealing. Borrowers may "trade off' changes in any loan parameter in exchange for other adjustments. The borrower, at this time, may "purchase" a larger credit ration for a price. Supporting empirical evidence is presented. RECENTLY, RESEARCHERS HAVE BEGUN to study the determinants of loan commitment or line of credit contracts. Such contracts play an extremely important role in bank credit allocation. According to the Federal Reserve Bulletin, over 70% of U.S. commercial and industrial loans are made under loan commitment contracts. Given the central importance of the institution, it is not surprising that it is the subject of a growing literature. Loan commitment contracts have importance both at the micro level, in terms of the bank-customer relationship, and at the marco level, in terms of the channels of operation of monetary policy.In this paper, we seek to present and test empirically an analytic model of loan commitment contracts. Our paper differs from most previous work in that we include empirical analysis of credit allocation. Moreover, most previous theoretical work on the subject has concentrated on the specific issue of pricing of the contracts, often using an approach based on option theory, and not on the quantity allocation of credit and its determinants. We are particularly interested in the determinants of the quantitative allocation of credit to bank customers, and in the composition of and trade-offs among the various parameters comprising such a loan commitment "package." Our model helps explain how contract terms are established in the market and will illuminate the institutional framework of commercial lending.A view of the credit contract as a "package of loan terms" has been implied recently in connection with the credit rationing problem.' Studies by Azzi and Cox [21, Arzac, Schwartz, and Whitcomb [11 and Koskela [81 show that the respectively. We wish to thank R. N. Vaughn, R. Waggoner, and J. Whittle for their assistance during the data collection phase of this study. We are indebted to Dwight M. Jaffee and Paul Wachtel for helpful comments on an earlier draft. Thanks are due also to the anonymous reviewers for thoughtful comments which improved the paper considerably. Financial support from the Zimmerman Foundation for Research in Banking and Finance is gratefully acknowledged. 1 Over the past two decades, the possibility of quantity restrictions in the credit market has been a leading theme in the literature. In particular, the possibility of nonprice credit rationing has been widely discussed. Such rationing is said to occur when interest rates on bank loans are set below their market clearing rates, resulting in some form of excess demand (see Freimer and Gordon [5]). Recent 425 Lending Contracts and Credit Allocation 435 9.

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“…Loan commitments are like forward contracts where the terms of the exchange specify a future delivery of credit. Two articles (Campbell, 1977;Deshmukh et al, 1982) have extended the theory of the banking firm by focusing on the optimal quantity of loan commitments when commitment takedowns are uncertain and the bank faces a funding risk. This extension of the literature seems warranted given the estimate by Boltz and Campbell (1979) that over 55% of the business loans at large money center and regional banks in 1977 were made under loan commitment agreements.…”

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confidence: 99%

Variable‐rate loan commitments, deposit withdrawal risk, and anticipatory hedging

Koppenhaver

1985

Journal of Futures Markets

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he obvious elements in a bank's balance sheet that can benefit from the risk-T shifting possibilities of financial futures trading are nonloan assets such as _ _ government securities, or variable-rate deposits such as money market accounts (see Ciccehetti et al., 1981;Ederington, 1979;Franckle, 1980;Parker and Daigler, 1981). Less research exists on the usefulness of financial futures contracts in commercial lending operations (for exceptions, see B a t h , 1983; Dew and Martell, 1981;Koppenhaver, 1983). In the only other published theory on loan commitments and financial futures, Ho and Saunders (1983) develop a model to determine a hedge of fixed-rate commitment takedowns when funding costs are subject to interestrate risk. In contrast, this article shows that financial futures contracts can help manage the interest rate and takedown uncertainty associated with making variablerate loan commitments when deposits are subject to withdrawal risk. The results of this investigation are that the anticipatoiy hedge of interest rate and quantity risks will be greater: (1) the greater the expected fall in interest rates, (2) the more ineiastic the demand for credit by borrowers, and (3) the smaller the problem of disintermediation. Using alternative assumptions about the formation of expectations and t h e risk aversion of bank management, a simulation of the optimal futures trading strategy using bank data from the Seventh Federal Reserve District indicates that up to 10% of the variability of unhedged profits could be eliminated by T-bill futures hedging.There are two general types of loan commitments used in practice: fixed-rate and variable-rate. In a fixed-rate loan commitment the lender provides credit on demand up to some previously determined quantity at a constant, known interest rate. In a variahle-rate loan commitment the lender provides future credit on demand up to some niaximum quantity at a price determined by a previously specified formula

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Bank Forward Lending in Alternative Funding Environments

Cited by 16 publications

References 0 publications

An economic rationale for the pricing structure of bank loan commitments

An economic rationale for the pricing structure of bank loan commitments

Loan Commitment Contracts, Terms of Lending, and Credit Allocation

Variable‐rate loan commitments, deposit withdrawal risk, and anticipatory hedging

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