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Syndication and Second Loan Sales

Syndication gives originating banks the opportunity to diversify part of their credit risk by selling loans to other members of the syndicate. However, as originating banks are less exposed to risk, their incentives to monitor borrowers diminish. We explore this trade-off with a theoretical model and show that in equilibrium loans trade at a discount because monitoring effort is sub-optimally low. We illustrate how this inefficiency is related to lack of transparency in the secondary loan market, and provide policy implications to address this problem.