Essays on relationship-oriented bank lending arrangements

This dissertation consists of three essays on bank loan commitments. The first essay is an in-depth review of the loan commitment literature. The other two essays shed light on the following stylized facts about loan commitments. First, since the early 1980s, the courts have often obstructed the bank's right to deny credit to a loan commitment owner by invoking the Material Adverse Change (MAC) clause, arguing that the bank did not act in "good faith". What is surprising is that the existing literature suggests that the MAC clause has economic value. So, the courts' behavior in invalidating the MAC clause has remained a puzzle. Second, the Federal Reserve's Senior Loan Officer Survey (1988) shows that borrowers view the guarantee against being rationed that is provided by a loan commitment as the most important reason for buying loan commitments. The current literature does not explain the existence of loan commitments based on the borrower's need for insurance against credit rationing. Third, although a large percentage of short-term C&I lending is done under loan commitments, for loans with short repricing intervals, this percentage is significantly small. Finally, borrowers are using a declining fraction of their available credit lines, while the commitment demand, expressed as a percentage of total bank lending, is stable.In the third chapter, I develop an economic model of economically rational litigation to explain why the courts have been intervening to enforce loan commitment contracts that are discretionary. I show that agents with contracting discretion will sometimes use the discretion in a manner that violates the "spirit" of the contract. That is, there is a non-zero probability that the seller of the discretionary contract will use the discretion not to recalibrate its obligation under the contract due to arrival of new information, but to merely exploit this discretion for personal gain. If the probability of such abuse becomes sufficiently large, courts annul discretionary clauses and make discretionary contracts enforceable ex post.In the fourth chapter, I model the tension between the protection-against-credit-rationing guarantee of a loan commitment and the cost to the bank of carrying the liquidity reserves needed to meet its (future) contractual commitment. This allows me to explain the last three stylized facts about this market.