Our purpose is to examine the circumstances under which enduring customer relationships (such as revolving credit agreements) will become predominant. We compare loan commitment contracts, under which borrowers may take down funds at fixed marginal mark up, to spot lending, under which funds are priced in consideration of customers' leverage. Under the first arrangement, insurance against default risk is priced as a fixed front-end fee. Under the second arrangement, it is priced under a rising leverage-specific markup schedule. We show that when default risk is independent of take down, the loan commitment contract will always dominate spot loans. When default risk increases with credit use, spot loans may become dominant.
Bibliographical noteFunding Information:
*We are indebted to Eli Talmor, the discussant of this paper, for insightful comments. Financial support from the Rubin Zimmerman Foundation for the Study of Banking and Finance at the University of Haifa is gratefully acknowledged.
ASJC Scopus subject areas
- Economics and Econometrics