In this article, I suggest a theoretical explanation for the recent spectacular growth of the loan sales market in terms of both quantity and quality. I show that banks can use loan sales as a strategic tool in order to preserve their informational advantage in a competitive environment. I consider a two-period competition model where banks acquire private information about their clientele during the lending relationship and where there is informational asymmetry in the loan sales market. In spite of the information dilution costs incurred in selling high-quality loans, banks have an incentive to imitate low-quality loan holders by selling their loans in order to avoid communicating negative signals about the quality of their clientele to potential competitors. As a result, loan market competition can lead to the emergence of a liquid loan sales market in which both low- and high-quality loans coexist, thereby improving the quantity and quality of the loan sales market. Copyright (c) 2010 The Author. Journal compilation (c) International Review of Finance Ltd. 2010.
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