Abstract

We study the design of measurement rules when banks engage in loan transfers in secondary credit markets. Our model incorporates two standard frictions: 1) banks’ monitoring incentives decrease in loan transfers, and 2) banks have private information about loan quality. Under only the monitoring friction, we find that the optimal measurement rule sets the same measurement precision regardless of bank characteristics, and strikes a balance between disciplining banks’ monitoring efforts vs. facilitating efficient risk sharing. However, under both frictions, uniform measurement rules are no longer optimal but induce excessive retention, thus inhibiting efficient risk sharing. We show that the optimal measurement rule should be contingent on the amount of loan transfers. In particular, measurement decreases in the amount of loan transfers and no measurement should be allowed when banks have transferred most of their loans. We relate our results to current accounting standards for asset transfers.