Do Banks Compete on Non-Price Terms? Evidence from Loan Covenants

We investigate the link between competition and non-price loan terms by exploiting a regulatory shock to banks’ ability to offer covenant-lite loans. As regulated banks demand more covenants, borrowers trade off staying with banks and receiving lower interest rates, but with covenants, against switching to other lenders with covenant-lite loans. The least covenantsensitive borrowers stay with regulated lenders and enjoy improvements in other loan terms, whereas weaker borrowers switch to the shadow banking segment, with the most marginal borrowers dropping out of the market completely. On aggregate, borrowers switch to unregulated lenders, leading to a decline in banks’ market share.