What Drives Global Lending Syndication? Effects of Cross-Country Capital Regulation Gaps

What Drives Global Lending Syndication? Effects of Cross-Country Capital Regulation Gaps
Janet Gao, Yeejin Jang
Review of Finance, Volume 25, Issue 2, March 2021, Pages 519–559, https://doi.org/10.1093/rof/rfaa019

The syndicated lending market is highly globalized, whereby banks participate extensively in syndicates organized by banks from other countries. The total amount of globally syndicated loans has risen from $800 billion in the 1990s to over $2 trillion in the 2010s. U.S. banks, in particular, have doubled their allocation to foreign-led syndicates during the past two decades. What drives banks’ participation in foreign-led deals? Does the structure of global syndicates affect the type of loans and corporations being funded?

We examine how cross-country differences in capital regulations shape the structure of global lending syndicates. Using globally syndicated loans extended by banks from 44 countries, we find that strictly regulated banks participate more in syndicates originated by lead lenders facing less stringent capital regulations. This effect is robust to various specifications and is not explained by borrowers’ credit demand.

We hypothesize and provide evidence that global syndication facilitates the risk-taking of strictly regulated banks. Banks facing stringent capital regulations seek high-risk, high-yield loans to boost their profit. Risky loans are particularly attractive to strictly regulated banks when borrowers are located outside the border. This is because regulators generally have less information to assess the credit quality of foreign borrowers, and banks have some discretion to manipulate the associated risk exposure in their financial reports. To procure risky deals abroad, banks can rely on lead arrangers under lax capital regulation regimes. Such lead banks face fewer barriers in lending to risky and more opaque borrowers. They can thus accumulate experience in prospecting and contracting with those borrowers. As countries do not perfectly synchronize their capital regulations, strictly regulated banks can join the syndicates organized by a loosely regulated lead bank to access risky deals.

Consistent with the above arguments, we find that regulatory scrutiny in the participant country, indicated by standards for accounting transparency and the quality of regulation enforcement, mitigates the effect of regulation gaps on global syndication. Effects are also stronger when lead arranger banks have more experience lending to small and opaque firms, and when participant banks face more binding capital constraints.

Lending syndicates containing loosely regulated lead arrangers and stringently regulated participants extend loans to riskier borrowers, charge higher spreads, forego covenants more frequently, and incur higher default rates. A tightening of capital regulations in participant countries also increases the investment and growth of risky firms. Finally, we show that global syndication contributes to greater systemic risk exposures for both strictly regulated participant banks and loosely regulated lead arrangers.

We are the first to show that capital regulation gaps across countries affect the formation of global syndicates: Banks strategically choose syndicate partners to benefit from the capital regulation regimes they face. While such a syndication motive facilitates the access to credit by corporations, it also brings greater systemic risk exposure to lenders. As capital regulations are designed to promote the safety and soundness of banking systems, our findings generate implications for banks’ risk-taking incentives and the effectiveness of banking regulations.

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