Bank Loan Sales: A New Look at the Motivations for Secondary Market Activity

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Bank Loan Sales: A New Look at the Motivations for Secondary Market Activity

March 1999 Number 69

JEL classification: G21

Author: Rebecca S. Demsetz

Bank lending traditionally involves the extension of credit that is held by the originating bank until maturity. Loan sales allow banks to deviate from this pattern by transferring loans in part or in their entirety from their own books to those of another institution. This paper uses a new methodology to test the validity of two hypotheses regarding banks' motivations for selling and buying loans: (1) the comparative advantage hypothesis, that banks with a comparative advantage in originating loans sell and those with a comparative advantage in funding loans buy, and (2) the diversification hypothesis, that banks lacking the ability to diversify internally use loan sales and purchases to achieve diversification. A third hypothesis—that reputational barriers can limit access to the secondary market—is considered as well, with particular attention paid to the importance of affiliate relationships in explaining secondary market activity. Together, the evidence relating to these three hypotheses helps clarify the benefits of an active secondary loan market. It also generates predictions regarding the future of that market in a world of rapid consolidation and disappearing barriers to geographical expansion.

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