Lender Moral Hazard and Reputation in Originate-to-Distribute Markets

Abstract

In a dynamic model of originate-to-distribute lending, we examine whether reputation concerns can incentivize a bank to monitor loans it has sold. Investors believe that banks with fewer recent loan defaults are more likely to monitor ("have higher reputation''). In equilibrium, banks monitor more and retain a smaller loan fraction when their reputations are high. Monitoring is harder to sustain in periods with uncommonly large spikes in loan demand ("booms''), especially for low-reputation banks, which are more likely to accommodate boom demand and forgo monitoring. Increased likelihood of facing a rival with reputation concerns also weakens monitoring incentives.

Keywords: Monitoring, Reputation, Default

JEL Classification: G20, G21, L14