Liquidity crisis,relationship lending and corporate finance

This paper investigates the consequences of the liquidity shocks in wholesale funding markets during the 2007–2009 financial crisis on bank lending and corporate financing. We show that banks that relied more heavily on wholesale funding contracted lending more severely than banks that relied more on insured deposits. We then examine the effects of loan contraction on the financial positions of publicly traded firms. We find that both during and after the crisis, the change in leverage of bank-dependent firms is less than that of firms with access to public debt markets. In addition, bank-dependent firms rely more on cash than net equity issuance to finance operations. We also find that firms with established bank lending relationships weather the crisis better. Such firms are able to attain higher levels of leverage during the crisis, add to their cash holdings, secure new bank credit, and achieve higher profitability as a result.     

The effect of bank capital on lending: Does liquidity matter?

This paper uses a sample of quarterly observations of insured US commercial banks to examine whether the effect of bank capital on lending differs depending upon the level of bank liquidity. We find that the effect of an increase in bank capital on credit growth, defined as growth rate of net loans and unused commitments, is positively associated with the level of bank liquidity only for large banks and that this positive relationship has been more substantial during the recent financial crisis period. This result suggests that bank capital exerts a significantly positive effect on lending only after large banks retain sufficient liquid assets.     

Reserve Requirements,Liquidity Risk,and Bank Lending Behavior

Although reserve requirements (RR) have been used in emerging markets to smooth credit cycles, the transmission mechanism remains blurry. Using bank‐level data, we unveil the interaction of RR with bank lending. We identify a new channel that works through a decline in banks’ liquid assets and loan supply due to an increase in RR. “Quantitative tightening” through RR raises the short‐term funding needs of the banking system, which is met by collateralized central bank lending, thus depleting banks’ unencumbered liquid assets. Our results suggest that such a shift in bank liquidity is associated with a significant change in lending.     

Bank Heterogeneity and Interest Rate Setting: What Lessons Have We Learned since Lehman Brothers?

A substantial literature has investigated the role of relationship lending in shielding borrowers from idiosyncratic shocks. Much less is known about how lending relationships and bank‐specific characteristics affect the functioning of the credit market in an economy‐wide crisis. We investigate how bank and bank–firm relationship characteristics have influenced interest rate setting since the collapse of Lehman Brothers. We find that interest rate spreads increased by less for those borrowers having closer lending relationships. Furthermore, firms borrowing from banks endowed with large capital and liquidity buffers and from banks engaged mainly in traditional lending were kept more insulated from the financial crisis.     

Crises,Liquidity Shocks,and Fire Sales at Commercial Banks

If liquidity shortages cause financial crises, a lender of last resort can provide funds to banks facing potential fire sales. However, if funding problems primarily occur at banks with existing solvency problems, then government liquidity programs may not spur bank lending. We find that commercial bank funding does not typically dry up in a crisis, not even during the subprime crisis. Rather, weak banks are more likely to borrow less. Furthermore, banks rely more on deposits and newly issued equity than fire sales. When they do sell assets, they cherry pick assets in order to alleviate pressure from capital regulations.     

Bank risk and monetary policy

We find evidence of a bank lending channel operating in the euro area via bank risk. Financial innovation and the wider use of new ways of transferring credit risk have tended to diminish the informational content of standard bank balance sheet indicators. We show that bank risk conditions, as perceived by financial market investors, need to be considered, together with the other indicators (i.e., size, liquidity and capitalization), traditionally used in the bank lending channel literature to assess banks’ ability and willingness to supply new loans. Using a large sample of European banks, we find that banks characterized by lower expected default frequency are able to offer a larger amount of credit and to better insulate their loan supply from monetary policy changes.     

Risk Overhang and Loan Portfolio Decisions: Small Business Loan Supply before and during the Financial Crisis

We estimate a structural model of bank portfolio lending and find that the typical U.S. community bank reduced its business lending during the global financial crisis. The decline in business credit was driven by increased risk overhang effects (consistent with a reduction in the liquidity of assets held on bank balance sheets) and by reduced loan supply elasticities suggestive of credit rationing (consistent with an increase in lender risk aversion). Nevertheless, we identify a group of strategically focused relationship banks that made and maintained higher levels of business loans during the crisis.     

Dissecting Foreign Bank Lending Behavior During the 2008–2009 Crisis

This paper analyzes the lending behavior of foreign‐owned banks during the recent global crisis. Using bank‐level panel data for 51 countries, the paper explores the role of affiliate and parent financial characteristics, host location, as well as the impact of parent geographic origin and reach on foreign banks’ credit growth. Overall, the analysis finds robust evidence that foreign banks curtailed the growth of credit relative to other banks, independent of the host region in which they operate. Banks from the United States reduced loan growth less than other parent banks. Neither the global nor regional reach of parent banks influenced the lending growth of foreign affiliates. Parent capitalization and not parent funding explained the behavior of foreign bank credit growth during the global crisis. However, funding did affect the lending behavior of domestic and foreign banks in host countries, with those relying more heavily on deposits suffering a smaller decline in bank lending. Although not the focus of the paper, we also find that government‐owned banks played a countercyclical role in all regions.     

International financial stress spillovers to bank lending: Do internal characteristics matter?

The purpose of this paper is to unveil and assess the potential US financial spillover on Gulf Cooperative Council (GCC) bank lending and to check whether bank's internal characteristics shape such an effect or not. For this purpose, a dynamic panel model is estimated using the GMM system using data on an unbalanced panel of GCC banks over the period 2003–2018. We have found evidence of financial stress spillovers on bank lending and that their distributional impacts vary across time, banks size and capitalization. However, the role of banks liquidity in shaping the impacts of financial stress on lending is found to depend on dry-ups/abundance of market funding liquidity. The results are robust to both splitting the sample into pre- and post- crisis periods as well as to the inclusion of additional potential lending supply determinants.     

The International Transmission of Bank Liquidity Shocks: Evidence from an Emerging Market

I exploit the 1998 Russian default as a negative liquidity shock to international banks and analyze its transmission to Peru. I find that after the shock international banks reduce bank‐to‐bank lending to Peruvian banks and Peruvian banks reduce lending to Peruvian firms. The effect is strongest for domestically owned banks that borrow internationally, intermediate for foreign‐owned banks, and weakest for locally funded banks. I control for credit demand by examining firms that borrow from several banks. These results suggest that international banks transmit liquidity shocks across countries and that negative liquidity shocks reduce bank lending in affected countries.     

Bank loans for private and public firms in a liquidity crunch

Bank reliance on short-term funding has increased over time. While an effective source of financing in good times, the 2007 financial crisis has exposed the vulnerability of banks and ultimately firms to such a liability structure. We show that banks dependent on wholesale funding contracted their lending the greatest during the crisis. Our results suggest, however, that in the financial crisis vulnerable banks passed the liquidity shock only to public firms and not to private firms. Loans to private firms were affected through a different channel, largely through higher retained shares by lead arrangers. Consistent with standard models of financial intermediation with information asymmetry, vulnerable banks increased their monitoring of informationally opaque firms for which the potential for informational rents is the highest.     

Small business lending and the bank-branch network

I examine the role of bank’s distance to the borrower and the proximity of other lenders for the transmission of financial shocks across the bank network. I use a novel dataset of small business lending based on information from the Community Reinvestment Act, which measures lending at census tract groups within each county and yields rich variation in the bank–borrower and borrower–competitor distance. I document that small banks with increased liquidity from proximity to local oil booms, originate more loans to firms far from these booms, and lenders with above-average geographic exposure to residential booms reduce lending in census tract groups with stable house prices. Bank–borrower distance is important for credit expansions, with closer firms receiving more credit, but not for contractions. Proximity of competitors plays a key role: consistent with theoretical predictions, both credit expansions and contractions disproportionately affect markets where the bank faces higher competition.     

Bank-to-bank lending channel and the transmission of bank liquidity shocks: Evidence from France

Good liquidity is essential for the banking system to function properly and supply credit to the real sector. However, several banks all over the world face large shocks to their liquidity supply due to numerous factors. This study contributes to the literature on the transmission of liquidity shocks by investigating the bank-to-bank lending behavior of French banks during the global financial crisis (2008 and 2009). In addition, we examine the factors strongly influencing the liquidity of the interbank deposits market. First, using a fixed-effects model on a sample of 85 French banks for the period from 2005 to 2010, we find that the deposits channel plays an important role in the transmission of liquidity shocks across the banking system. Second, we use difference-in-difference methodology to study the effects of liquidity shock on bank lending. Our results show that French banks reduced their bank-to-bank lending significantly during the financial crisis period. Moreover, our results suggest that the reduction could have been due to deposit activities.     

Bank Capital and Lending Relationships

This paper investigates the mechanisms behind the matching of banks and firms in the loan market and the implications of this matching for lending relationships, bank capital, and credit provision. I find that bank‐dependent firms borrow from well‐capitalized banks, while firms with access to the bond market borrow from banks with less capital. This matching of bank‐dependent firms with stable banks smooths cyclicality in aggregate credit provision and mitigates the effects of bank shocks on the real economy.     

Bank lending margins in the euro area: Funding conditions,fragmentation and ECB's policies

In this paper we study the determinants of lending margins paid by euro‐area corporates for their bank loans. Across two separate groups of countries (distressed and non‐distressed) we examine whether lending margins have been affected by structural changes in the banking sector, the credit and liquidity position of banks and the costs of funding in the corporate and sovereign bond markets. The role of ECB policies with respect to narrowing down the fragmentation in the bank lending channel is also investigated through a structural panel VAR model for the period 2003:1 to 2014:12.     

Financial constraints of private firms and bank lending behavior

We investigate whether and how financial constraints of private firms depend on bank lending behavior. Bank lending behavior, especially its scale, scope and timing, is largely driven by bank business models which differ between privately owned and state-owned banks. Using a unique dataset on private small and medium-sized enterprises (SMEs) we find that an increase in relative borrowings from local state-owned banks significantly reduces firms’ financial constraints, while there is no such effect for privately owned banks. Improved credit availability and private information production are the main channels that explain our result. We also show that the lending behavior of local state-owned banks can be sustainable because it is less cyclical and neither leads to more risk taking nor underperformance.     

Flight to liquidity and the Great Recession

This paper argues that counter-cyclical liquidity hoarding by financial intermediaries may strongly amplify business cycles. It develops a dynamic stochastic general equilibrium model in which banks operate subject to agency problems and funding liquidity risk in their intermediation activity. Importantly, the amount of liquidity reserves held in the financial sector is determined endogenously: Balance sheet constraints force banks to trade off insurance against funding outflows with loan scale. A financial crisis, simulated as an abrupt decline in the collateral value of bank assets, triggers a flight to liquidity, which strongly amplifies the initial shock and induces credit crunch dynamics sharing key features with the Great Recession. The paper thus develops a new balance sheet channel of shock transmission that works through the composition of banks’ asset portfolios.     

Finance and inequality: The distributional impacts of bank credit rationing

We analyze reductions in bank credit using a natural experiment where unprecedented flooding in Pakistan differentially affected banks that were more exposed to the floods. Using a unique data set that covers the universe of consumer loans in Pakistan and this exogenous shock to bank funding, we find two key results. First, following an increase in their funding costs, banks disproportionately reduce credit to borrowers with little education, little credit history, and seasonal occupations. Second, the credit reduction is not compensated by relatively more lending by less-affected banks. The empirical evidence suggests that a reduction in bank monitoring incentives caused the large relative decreases in lending to these borrowers.     

Lending Booms and Lending Standards

We examine how the informational structure of loan markets interacts with banks' strategic behavior in determining lending standards, lending volume, and the aggregate allocation of credit. We show that, as banks obtain private information about borrowers and information asymmetries across banks decrease, banks may loosen their lending standards, leading to an equilibrium with deteriorated bank portfolios, lower profits, and expanded aggregate credit. These lower standards are associated with greater aggregate surplus and greater risk of financial instability. We therefore provide an explanation for the sequence of financial liberalization, lending booms, and banking crises observed in many emerging markets.     

Bank lending during the financial crisis of 2008

This paper shows that new loans to large borrowers fell by 47% during the peak period of the financial crisis (fourth quarter of 2008) relative to the prior quarter and by 79% relative to the peak of the credit boom (second quarter of 2007). New lending for real investment (such as working capital and capital expenditures) fell by only 14% in the last quarter of 2008, but contracted nearly as much as new lending for restructuring (LBOs, M&As, share repurchases) relative to the peak of the credit boom. After the failure of Lehman Brothers in September 2008, there was a run by short-term bank creditors, making it difficult for banks to roll over their short term debt. We find that there was a simultaneous run by borrowers who drew down their credit lines, leading to a spike in commercial and industrial loans reported on bank balance sheets. We examine whether these two stresses on bank liquidity led them to cut lending. In particular, we show that banks cut their lending less if they had better access to deposit financing and thus, they were not as reliant on short-term debt. We also show that banks that were more vulnerable to credit-line drawdowns because they co-syndicated more of their credit lines with Lehman Brothers reduced their lending to a greater extent.