The crisis as a wake-up call

Ralph De Haas, Neeltje van Horen

25 August 2010



The global financial crisis originated in the US subprime mortgage market, where banks gradually relaxed their screening and monitoring standards (Keys et al. 2010). Moreover, in a recent Vox column Mian et al. (2010) present evidence suggesting that banks may have influenced the decisions of the very policymakers whose were responsible for preventing irresponsible lending. Regardless of the reasons, the extent of the damage from the global crisis has forced policymakers to rethink how they regulate finance. Cecchetti and Cohen (2010) argue that “like an overweight victim recovering from a heart attack, the financial system must change its ways”.

While some, including Perotti (2010), argue that a more direct approach is needed to regulate banks, we look at how banks are changing by themselves. In recent research (De Haas and Van Horen 2010), we analyse the extent to which the subprime losses since autumn 2007 have changed the way banks screen and monitor standards, without the prompting of regulation.

To answer this question, we study changes in the syndicated loan market. This market is particularly well suited to assess changes in screening and monitoring because the structure of lending syndicates reflects the importance that banks attach to the screening and monitoring of borrowers (Sufi 2007). A short primer on syndications will make this clear.

Syndicated lending and “skin in the game”

Syndicated loans are provided by a group of financial institutions – the syndicate – to a single borrower. A typical syndicate consists of two tiers: arrangers and participants. The arrangers comprise the senior tier and negotiate the lending terms with the borrower. Arrangers usually allocate a substantial part of a loan to a junior tier of syndicate members, the participants. Participants have a more passive role: they buy a portion of the loan but are neither involved in its organisation nor in the screening and monitoring of the borrower.

Participants use arrangers as delegated monitors (Diamond 1984). A downside of this functional division is that the arranging banks have a reduced incentive to screen and monitor. To resolve this agency problem, the arrangers often retain a large loan portion on their own balance sheet (retention rate). Such “skin in the game” is an efficient mechanism to ensure that arrangers sufficiently screen and monitor (Pennacchi, 1988). We consequently argue that if participant banks became more concerned about screening and monitoring at the start of the crisis – a wake-up call – this should be reflected in a significant increase in retention rates.

By syndicating part of the loans they structure, arrangers free up space on their balance sheet. This allows them to originate additional loans and earn fee income. When arrangers only need to retain a small portion of each loan, they can originate many syndicated loans and the supply of lending is high. Conversely, when capital-constrained arrangers are required to retain a large loan portion, they are able to syndicate fewer loans and the supply of syndicated credit is reduced. Fluctuations in retention rates may thus be inversely related to the supply of syndicated lending. Indeed, Figure 1 shows how at the onset of the crisis in mid-2007 a sharp increase in retention rates was accompanied by a steep decline in syndicated lending.

Figure 1. Retention rate and syndicated lending volume

Note: The figure shows the evolution of the average retention rate and the volume of syndicated lending over the period January 2005-October 2009. Loans to (quasi-) government entities, loans where an international financial institution is a syndicate member, project finance loans and club loans are excluded. Retention rate measures the share of the loan jointly held by all arrangers. Total loan volume includes both loans with and without information on the loan shares held by individual lenders.

How the crisis increased retention rates

The econometric analysis in our paper shows that – even when we control for changes in inter-bank liquidity and borrower risk – the outbreak of the crisis led to a significant and robust increase in arrangers’ retention rates. This increase materialised during the early phase of the crisis – before the collapse of Lehman Brothers and the ensuing sharp output decline – and persisted over time.

We then test whether loan retention increased, in particular when information asymmetries between the syndicate and the borrower were large. Lenders likely became most concerned about adequate screening and borrowing in the case of such opaque loans. Similarly we expect that when information asymmetries were large within a syndicate – that is: between participants and arrangers – retention rates increased more as well. To analyse both layers of agency problems – between lenders and borrowers and among lenders – we exploit detailed information on market, borrower, and lender heterogeneity.

We find that retention rates increased significantly more – both in statistical and economic terms – when information asymmetries were high. Table 1 shows the economic magnitude of some of the significant differences we document in the working paper. While the retention rate for loans to first-time borrowers increased by almost 11%, arrangers of syndicated loans to borrowers with average borrowing experience (two and a half loans) only increased their retention rate by 7.6%. The necessary increase in loan retention was even smaller in cases when either the arrangers or the participants themselves had previously lent to the borrower or if they had substantial prior experience in lending to a borrowers’ industry or country. Finally we find that experienced arrangers needed to increase their retention rates much less than less experienced arrangers. Reputation limited the crisis-related increase in agency problems within lending syndicates.

Table 1. Economic significance of crisis impact on retention rates

Note: The table shows the economic significance of the crisis impact on retention rates for loans with varying levels of asymmetric information between borrower and syndicate or within the syndicate. The economic effects are calculated relative to the pre-crisis mean of the share of the loan jointly held by the arrangers.

Policy implications: Transparency, experience, and reputation

We find that more transparent borrowers, more experienced participants, and more reputable arrangers all helped to contain the crisis-related correction in screening and monitoring intensity and thus in retention rates. This strong link between the severity of information asymmetries and the increase in retention rates further underlines our argument that the overall increase in retention rates at the onset of the crisis, and the subsequent decline in syndicated lending, was at least partially caused by stricter screening and monitoring. To the extent that this reflects a reversal of the pre-crisis loosening of lending standards, banks’ continuing reluctance to lend may prove to be quite persistent even if banks’ own funding constraints gradually become less binding.

Our findings also bear on the current regulatory debate about minimum “skin in the game” retention rates for originating banks. In July 2009, the European Parliament amended the Capital Requirements Directive by including a 5% retention requirement for securitisations, while in May 2010 the US Senate passed the financial reform bill that announces the introduction of similar regulations. Earlier plans to let minimum-retention requirements not only apply to securitisations but also to syndicated loans have (at least for the time being) been shelved. At first sight, our results confirm that regulatory retention requirements may indeed not be necessary for syndicated loans. After all, we document a strong, broad-based but market-driven increase in retention rates among syndicate arrangers. Participant lenders, concerned about arrangers’ lax screening and monitoring, were in many cases able to take corrective action without regulatory intervention. Although syndicated lending declined sharply, the market did not break down. This stands in contrast to the securitisation market, where the link between the originator and the ultimate investors was too severed to make any corrective (and collective) action possible.

Yet this market-driven self-regulation may not last forever. Once the market for syndicated lending begins expanding again and financial institutions return to competing heavily to participate in (oversubscribed) syndicated loans, the pressure on arrangers to retain loan portions that are high enough to guarantee sufficient screening and monitoring may gradually erode. Without the introduction of some form of mandatory retention rates for syndicated loans, the risk exists that old practices will soon return. This risk is greater if the secondary market for syndicated loans, where both arrangers and participants can offload their loan stakes, returns to its former levels. One way to reduce such a negative impact of subsequent loan sales is to require arrangers to hold on to the loan portion they retained at origination. Although such a requirement could be introduced through legislation, participants themselves could also start demanding that their loan contracts include restrictions on subsequent loan sales by arrangers.


Cecchetti, Stephen and Benjamin H Cohen (2010), “Strengthening the financial system: The benefits outweigh the costs”,, 20 August.

De Haas, RTA and N Van Horen (2010), “The crisis as a wake-up call. Do banks tighten screening and monitoring during a financial crisis?” DNB Working Paper No. 255 / EBRD Working Paper No. 117, Amsterdam/London.

Keys, BJ, T Mukherjee, A Seru, and V Vig (2010), “Did securitization lead to lax screening? Evidence from subprime loans”, Quarterly Journal of Economics 125: 307-362.

Mian, Atif, Amir Sufi, Francesco Trebbi (2010), “The political economy of the subprime mortgage credit expansion”,, 11 July.

Pennacchi, G (1988), “Loan sales and the cost of bank capital”, Journal of Finance 43, 375-396.

Perotti, Enrico (2010), “We must escape the grip of short-term funding”,, 5 July.

Sufi, A (2007), “Information asymmetry and financing arrangements: Evidence from syndicated loans”, Journal of Finance 62, 629-668.



Topics:  Global crisis International finance

Tags:  subprime crisis, financial regulation, global crisis

Director of Research, EBRD

Research Advisor Bank of England and CEPR Research Fellow