Why the Borrower Cannot Simply Walk Away
The subject now is the borrower’s bargaining position after a bank has written a stricter covenant, not just the bank’s ability to enforce it. The focus is why the Federal Reserve study finds no reliable lower-spread compensation for stricter terms, why the effect is stronger for firms with high switching costs, and what the July 2026 ECB survey adds as current context. The practical judgment is distributional: a contractual option may be useful for a lender, but its burden depends on whether the borrower can find another source of credit.
The price is not the same as the control right
A borrower choosing a loan normally compares more than the interest rate. The firm also cares about the amount of credit available, the maturity, collateral requirements, reporting obligations, and the conditions that allow the lender to intervene. A lower spread can compensate for a more restrictive contract, but it does not have to. A cheaper loan with a tighter covenant may still become more expensive in practice if a breach removes liquidity at the moment the firm needs it.
The Federal Reserve study tests whether borrowers receive that kind of price compensation from banks with greater monetary-policy exposure. It examines loan spread as the outcome in the same broad contract framework. In specifications without the full set of bank and loan characteristics, the exposure coefficients are positive and significant. Once those characteristics are included, the coefficients become insignificant. The study therefore finds no robust evidence that high-exposure banks offer lower interest spreads in exchange for stricter covenants.
That result separates two dimensions of a loan that are often collapsed into one. The spread is the price paid for borrowing. A covenant defines a condition under which the lender may gain more control over the relationship. The absence of a stable spread discount means that the borrower may be accepting additional conditional control without receiving a reliably lower stated price. It does not mean the covenant has no value to the borrower. Monitoring and financial boundaries can help contain creditor risk and make a loan possible. It means that the data do not show a general, measurable trade-off in which every additional restriction is purchased with cheaper credit.
Why would a firm accept the terms? Lending relationships are usually built over time. A bank accumulates information about a borrower’s finances and operations, while the borrower builds processes around the bank’s systems, reporting requirements, and funding capacity. Replacing that relationship can require finding another lender, supplying information again, negotiating a new contract, and accepting uncertainty about whether the new lender will provide the same amount or timing of credit. The firm may also need financing quickly, making a theoretical alternative less useful than a relationship already in place.
These frictions are not distributed evenly. A large, transparent firm with several banks and readily verifiable accounts may be able to solicit competing offers. A smaller or younger firm may be less able to demonstrate its quality to a new lender. Information about the borrower may be partly proprietary and accumulated through repeated interactions, so a new bank cannot reproduce the relationship immediately. A firm with fewer assets that can be pledged as collateral may also have fewer ways to replace a restrictive loan.
Financial distress creates another constraint. A highly leveraged firm or a firm with a low Altman Z score may face a greater probability of financial difficulty and fewer attractive financing alternatives. The firm may accept a tighter covenant because preserving access to a current lender is more urgent than waiting for a better contract. The important point is not that distress makes a borrower passive in every negotiation.