Syndication, Interconnectedness, and Systemic Risk∗

This paper studies the interconnectedness of banks in the syndicated loan market as a major source of systemic risk. We develop a set of novel measures to describe the "distance" (similarity) between two banks’syndicated loan portfolios and find that such distance explains how banks are interconnected in this market. As lead arrangers choose to work with those that have a similar focus in terms of lending expertise, there is a high propensity of bank lenders to concentrate syndicate partners rather than to diversify them. We find some evidence of potential benefits of this behavior as to lower costs of screening and monitoring, for example, higher shares of the loan taken by more connected lenders and lower loan spreads if syndicated lenders are more connected. Lastly, we find that the most heavily interconnected lenders in the syndicated loan market are also the greatest contributors to systemic risk, suggesting important negative externalities associated with the syndication process.