BANK BEHAVIOR-BASED ON INTERNAL CREDIT RATINGS OF BORROWERS

This study examines the relation of bank loan terms to borrower risk d efined by the banks' internal credit rating. The analysis is not restr icted to a static view. It also incorporates rating transition and its implications on the relation. Money illusion and phenomena linked wit h relationship banking are discovered as important factors. The result s show that riskier borrowers pay higher loan rate premiums and rely m ore on bank finance. Housebanks obtain more collateral and provide mor e finance. Caused by money illusion in times of high market interest r ates loan rate premiums are relatively small whereas in times of low m arket interest rates they are relatively high. There was no evidence f or an appropriate adjustment of loan terms to rating changes. (C) 1998 Elsevier Science B.V. All rights reserved.