Abstract - Multi-bank loan pool contracts: enhancing the profitability of small commercial banks

We show that multi-bank loan pool contracts improve the risk-return profile of banks’ loan business. Banks write simple contracts on the proceeds from pooled loan portfolios, taking into account the free-rider problems in joint loan production. Thereby especially smaller banks benefit greatly from diversifying credit risk while limiting the efficiency loss due to adverse incentives. We present calibration results for a sample of German savings banks: the formation of loan pools reduces the volatility in default rates, proxying for credit risk, of loan portfolios by roughly 80 percent. Under reasonable assumptions, the gain in return on equity (in certainty equivalent terms) is around 200 basis points annually.

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