While theoretical papers have emphasized the importance of bank loan monitoring, empirical papers have struggled to validate these theories, largely due to limited data availability. Using a proprietary transaction-level database of nearly 30,000 multiple-draw construction loans, we empirically examine the determinants and effects of bank monitoring through on-site inspections. Consistent with theoretical predictions, banks trade off monitoring with favorable origination terms. Monitoring is less frequent when the bank has a prior relationship with the borrower, suggesting information transfers across projects. Monitoring intensity increases when local economic conditions or bank health deteriorate. Textual analysis shows that negative inspection reports are associated with a greater likelihood of banks denying draw requests, indicating that the information collected through monitoring is important for decision-making. Finally, we provide a comprehensive analysis of construction loan default and show that monitoring decreases default. Overall, our results validate the predictions of a large theoretical literature emphasizing the important role of bank monitoring.

In classic theories of financial intermediation, banks mitigate information frictions by monitoring and producing information about borrowers. However, it is difficult to test these theories without access to banks' private information. In this paper, we use supervisory data containing banks' private assessments of their loans' expected losses. We show that changes in expected losses predict firms' future stock returns, bond returns, and earnings surprises, and that banks use this information to allocate credit. Our findings show that banks' information production and monitoring create an information advantage over financial markets, even among publicly traded firms.

We build on previous work and provide a dynamic model of asset markets with asymmetric information where higher originator screening effort leads to more signaling through delay of sale. We test this theoretical prediction using the mortgage market as a laboratory and processing time as a measure of screening. Our findings are threefold: First, and in line with the theory, mortgage processing time and the delay of sale after origination are strongly positively related in the data. Second, the processing time is longer for mortgages with higher ante credit risk, i.e., observably riskier loans are processed slower. Finally, both processing time and delay of sale are negatively related to conditional mortgage default, indicating that more screening effort leads to unobservably higher quality loans that are also sold with a longer delay.